A REVIEW OF U.S. AND INTERNATIONAL MARKETS
June 22, 2022
Since U.S. stocks have outperformed international stocks for more than a decade, as shown in the table and charts below, clients often ask for our insight on the benefits of investing in international markets. Despite U.S. stock outperformance, international markets have an important role to play as part of a diversified portfolio.
Aside from showing that the total U.S. stock market experienced a strong 10+ year return relative to international markets, the data also illustrates a few other points. For one, in this recent period of stress, the U.S. market is down 20%+ year-to-date as of 6/16/22 (a decline of 20% or more from the prior peak is often defined as a bear market). While returns are still negative across all markets, international stocks have held up slightly better, despite suffering more severe disruptions due to COVID-191 and being geographically closer (and more exposed) to the Russia-Ukraine War.
By taking a broader look at history, we can also see that U.S. and international markets tend to trade leadership as illustrated in the chart above, and that there have been extended periods of outperformance for non-U.S. markets. We believe it is reasonable that this could happen again. The table below, a 20-year summary from our Fourth Quarter 2020 Market Commentary, illustrates that international exposure has protected us from lost decades in the U.S., like the 2000s, while contributing to strong returns over multiple decades.
Looking under the hood at different markets highlights reasons why the U.S. and international markets complement each other and why there can be extended periods of relative outperformance. Over the past 10+ years, technology companies have done well amid a low interest rate environment and other factors. When analyzing the composition of the U.S. market, we recognize that technology is the biggest sector while it is a less significant sector in international markets, which helps explain the past decade of outperformance. Conversely, these sector compositions can also explain why international markets (with greater exposure to energy, commodities, materials, etc.) have held up a bit better recently, and why they tend to do better than the U.S. during periods of inflation, or when the dollar is weakening, thus boosting international returns in past inflationary environments.2
While reviewing past drivers of market returns is important, we also must keep an eye toward the future and analyze what could drive future returns. In the table below, there are a few interesting aspects. For one, the U.S. only makes up about 4% of the world population. There isn’t a significant expectation that population growth in the U.S. will be as strong as in foreign countries,3 so growing our gross domestic product (GDP) may depend on getting foreigners to buy our products. However, we would expect them to prefer buying local products when possible, boosting international market returns. From a nominal GDP perspective, we have the largest economy in the world at about 24%, but that is shrinking as China and other economies modernize. Despite these potential imbalances, the size of the U.S. stock market still stands at roughly 60% of the world market.
Even though stock market valuations aren’t useful from a market timing perspective, they should hold some importance over the long term.4 Looking at data from J.P. Morgan in the graphic below, we can see that relative to historical price-to-earnings (P/E) ratios, the U.S. market looks slightly elevated on a forward P/E ratio basis, while most international markets look inexpensive. This is important because over the long term, history shows that being able to pay less for an asset can lead to higher future returns.
Putting absolute market returns aside, despite being perceived as riskier, international investing can help reduce volatility over the long run as illustrated by the Vanguard chart below. This shows that while any market can have high volatility in isolation, building a diversified global market portfolio and being able to rebalance across different regions can lead to lower volatility than just having a U.S. stock market portfolio.
Taken as a whole, we arrive at several conclusions. Empirical data demonstrates that investing in international markets helps to reduce risk from a volatility standpoint. Given the fact that we cannot predict the future, international investing can reduce the risk of suffering through a lost decade in the U.S., which could be caused by geopolitical events, missteps by our own national leaders, relative market valuations, U.S. companies falling out of favor, or a litany of unseen potential reasons. From a return perspective, while we believe that a diversified approach means we may not capture the highest potential returns in the world, we believe we can do better than those who don’t diversify, if we avoid lost decades. We believe that controlling what we can, based on what evidence shows, is what we must do. And most importantly, we believe that a globally diversified portfolio will allow our clients to navigate an unknowable future, while still producing returns that will help them attain their long-term goals. Please reach out to your trusted advisor with any questions you may have.
1 Statista, “Impact of the coronavirus pandemic on the global economy: statistics & facts,” M. Szmigiera, May 26, 2022.
2 “Schwab Market Perspective: Downshifting,” Liz Ann Sonders, Jeffrey Kleintop, and Kathy Jones, May 13, 2022.
3 Brookings, “U.S. Population growth has nearly flatlined, new census data shows,” William H. Frey, December 23, 2021.
4 Columbia ThreadNeedle Investments, “Valuation and Expected Return,” Alex Rivas, February 2019
The Mather Group, LLC (TMG) is registered under the Investment Advisers Act of 1940 as a Registered Investment Adviser with the Securities and Exchange Commission (SEC). Registration as an investment adviser does not imply a certain level of skill or training. For a detailed discussion of TMG and its investment advisory services and fees, see the firm’s Form ADV on file with the SEC at www.adviserinfo.sec.gov, or on the firm’s website at www.themathergroup.com. The opinions expressed, and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The opinions and advice expressed in this communication are based on TMG’s research and professional experience and are expressed as of the publishing date of this communication. All return figures and charts are sourced and shown are for illustrative purposes only. TMG makes no warranty or representation, express or implied, nor does TMG accept any liability, with respect to the information and data set forth herein. TMG specifically disclaims any duty to update any of the information and data contained in this communication. The information and data in this communication does not constitute legal, tax, accounting, investment, or other professional advice. Investing involves some level of risk. Past performance does not guarantee future results.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Please feel free to contact us for additional information on any indices mentioned.
Indexes
- Standard & Poor's (S&P) 500 - A stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
- MSCI EAFE: Index of large- and mid-cap companies of 21 Developed Market countries in Europe, Australasia, & the Far East.
- MSCI USA: Index designed to measure the performance of the large- and mid-cap segments of the U.S. market. With 626 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the U.S.
