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Why, How and Now of Global Investing, Part III
January 18, 2018

In the previous two blogs, we provided our investment philosophy and policy regarding one of the core tenants of our investment strategy; i.e. global investing. Lastly, we provide our opinion on the current opportunities regarding international equities. Is it a good time to be a global investor?

The current environment (Now) – Not only has the US market been in its longest bull market in history, but it also is in one of its longest stretches of out- performance over international equities. The US economy was the first of the developed economies to recover from the financial crisis and its stock market has performed in tandem. Since the market low of March 9, 2009 through December 31, 2017 the S&P 500 is cumulatively up 375.68% while the MSCI EAFE is up only 204.10%. (Source: Bloomberg 2017)

The most significant divergence in US out-performance over international equities has occurred in the last 5 years. For the five years ending 12/31/2017, performance has tilted to the US with the S&P 500 up 108.05% and the MSCI EAFE up only 50.40%.

As we close out 2017, international markets have out-paced US markets in a rare turn of events. The question becomes is this an anomaly or signs of a rotation to more investor interest in the international markets?

Returns for the one year period ending 12/31/2017:

S&P 500 – 21.82%

MSCI EAFE – 25.69%

MSCI EM – 37.51%

We believe the rotation to international and emerging market out-performance is inevitable. It may have begun with 2017 and a cycle of out-performance that could last many years.

From

To

Outperformer

By

Apr 30, 1971

Mar 30, 1973

MSCI EAFE

62.2%

Mar 30, 1973

Oct 31, 1976

S&P 500

30.5%

Oct 31, 1976

Oct 31, 1980

MSCI EAFE

90.0%

Oct 31, 1980

Oct 31, 1982

S&P 500

34.1%

Oct 31, 1982

Feb 28, 1989

MSCI EAFE

409.4%

Feb 28, 1989

Aug 31, 2000

S&P 500

490.6%

Aug 31, 2000

Nov 30, 2007

MSCI EAFE

60.5%

Nov 30, 2007

Dec 31, 2017

S&P 500

98.82%

Source: Bloomberg 12/31/2017

Following are selected recent valuation metrics for the US and the world-ex the US:

Region

PE Ratio

Dividend Yield

US (S&P 500)

18.20

2.00%

ACWI ex-US

14.x

3.10%

Source: MSCI, Standard & Poors, FactSet, JP Morgan GTM 1Q 2018

The US stock market has traditionally received a higher valuation and risk premium than other global markets. US rule of law, US business expertise and the US focus on shareholder value justifies higher domestic valuations vs international valuations. However, today’s PE ratios reflect a wider gap in valuations than the historic averages. This is particularly true for emerging markets and creates a potentially better entry point for capital and potentially higher future returns for international and emerging market equities.

Given the strong move in US stock markets and the current low interest rate environment, our intermediate-term forward looking prospects for stocks and bonds are modest and below long-term averages. Stable, predictable and higher yielding investments are difficult to uncover in today’s investment opportunity set. According to a Capital Ideas piece from the American Funds dated December 9, 2016, they identified 786 stocks that yielded more than 3%. Over 372 or 47% of the stocks were in the developed international stock arena, 296 or 38% were identified in the emerging market asset class and only 118 or 15% were in the US. In our opinion, this higher dividend income is a positive stabilizer to cash needs and return expectations looking forward.

The US was the quickest developed economy to recover from the financial crisis. This contributed to the strong and concentrated recovery of its stock market among global markets. Europe, Japan and other global economies have begun to show signs of turning their economies around. Both political and economic forces in the international markets are improving. Signs of populism are slowing, GDP growth is accelerating, unemployment is improving and consumer confidence is rising.

The US dollar continues to be the globe’s primary currency for conducting business. However, as the wealth of nations grows parity in the value of currencies may improve. The dollar has been in an extended period of strength against many of the other major currencies. It began in 2011 as the US began its recovery from the financial crisis. Now that other major economies are beginning to show signs of recovery, it is possible the US dollar may weaken against some other major currencies. Strengthening values in foreign currencies would make the return on foreign investments held by US investors more attractive.

In the last 35+ years, extreme poverty on the globe has gone from over 40% of the population to just north of 10%. (Capital Ideas 12/9/2016; The World Bank, Luxembourg Study) With estimates of 2 -4 billion people moving toward middle class status outside the US during the next several decades, the US percentage of the world’s GDP and investment opportunity set is likely to lessen.

If the purpose for investing is to explore a wide set of investment opportunities within your sphere of competence, while managing the associated risks, in our opinion, investing in the ownership of companies in the US and abroad is the basis for a prudent and profitable long-term investment policy. The United States remains the beacon of capitalism, shareholder focused companies and an environment with dependable rule of law. The US deserves a significant weighting in portfolio construction because of these things.

However, given the unprecedented growth of global capitalism and a burgeoning middle-class, international investment opportunities could be a significant weighting in long-term growth portfolios in the coming decades. Given current valuations, we believe the current global investment landscape warrants a significant weighting to international developed and emerging market stocks.

 

Views expressed are those of the author and not necessarily those of Raymond James & Associates and are subject to change without notice. Information contained herein was received from sources believed to be reliable, but accuracy is not guaranteed. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Past performance is not indicative of future results. There is no assurance these trends will continue or that forecasts mentioned will occur. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. The process of rebalancing may carry tax consequences. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. The MSCI World Index is designed to measure the equity market performance of developed markets. It tracks 23 countries including the United States. Past performance may not be indicative of future results. It is not possible to invest directly in an index.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. MSCI Emerging Markets Index is designed to measure equity market performance in 23 emerging market countries. The index's three largest industries are materials, energy, and banks. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing involves risk and investors may incur a profit or a loss. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

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