A look beyond the U.S. market
The non-U.S equity markets have been experiencing a difficult stretch. Over the last five years we have seen non-U.S. developed markets trail the U.S. stock market by almost 6% per year1. These results, combined with concerns about Europe, have led many investors to contemplate reducing or abandoning non-U.S. stocks in their portfolio. While avoidance may seem like a “safe” play, the validity of this decision may need to be questioned.
We know that leadership ebbs and flows among equity markets. Markets have experienced similar five-year periods before, and we have always seen the trend reverse. In fact, over the long-term (1970 – June 2012), the difference between the U.S. equity market (Russell 3000 Index and S&P 500 Index) and the non-U.S. equity markets (Russell Global ex-US and MSCI World Indexes) has been only 20 basis points per year on average, with the non-U.S. markets holding the slim lead.
Unfortunately in these periods when sentiment about a market is negative and recent performance results “support” the view, long-term perspective gets trampled as investors run out the door. This results in investment strategies designed to meet long-term goals being thrown out in favor of feeling better in the short-run. This wouldn’t be a problem if investors had demonstrated a history of sound market timing decisions. However, you would be hard pressed to find any studies supporting that notion.
To help investors who are contemplating a move away from non-U.S. markets, one suggestion is to get them thinking about the first principles of investing…what view do the fundamentals support? How do the markets match-up and compare? Are there signals indicating that action should be taken?
The difficulties experienced outside the U.S. has created an environment in which non-U.S. markets are being priced as relatively inexpensive compared to the U.S. This is demonstrated in the chart below where the U.S. is the most expensive stock market listed, as measured by the Price/Earnings Ratio, a very common measure of value. “Safety” can be very expensive. Valuations can have a significant impact on long-term returns, buying less expensive is often a sound strategy.
Another factor that may capture investors’ attention is yield. Given today’s low interest rate environment, it is not unusual to hear investors turning to the equity markets for dividend yield opportunities. The U.S. stock market is yielding more than the ten-year Treasury2 at this point in time. However, what many investors likely do not know is that the U.S. is now among the lowest yielding equity markets. The chart below shows that the U.S.’s dividend yield of 2.2% trails the other major markets by a minimum of 50 basis points, with the lone exception of India.
Taken together, the U.S. is currently more expensive than other countries and yielding considerably less than other markets as well. This is not to say that the U.S. equity market is a bad investment at this time. It simply suggests that there is potential for attractive investment opportunities outside the U.S. that investors avoiding these markets are likely to miss. For those investors looking to take advantage of the opportunities both inside and outside the U.S., a globally diversified equity exposure may be a good way to go.
1Non-U.S. equity markets represented by Russell Developed ex-U.S. Large Cap Index (-5.50% annualized returns for five-year period ending June 30, 2012) and U.S. equity markets represented by Russell 3000® Index (-0.29% annualized returns for five-year period ending June 30, 2012)
210-year treasury yield as of 7/23/12 is 1.47%. Source: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield; dividend yield of U.S. based on Russell Global U.S. Index as of May 31, 2012.