Ever since the Great Recession of 2009, U.S. stocks have outperformed Europe and other developed economies. While stocks around the world have generally done well over the last decade, strength in the U.S. dollar brought capital in from overseas, which added to buying interest in our stock market. In the period between 2010 and 2017, U.S. stocks returned over 13% per year, compared to just 4% per year for emerging markets.
The Dollar’s Effect on Global Investment Capital
Now, with the U.S. dollar having weakened over the last year, investors have increased their focus on international stocks. The U.S. dollar (USD) remains the world’s benchmark currency. Every developed economy holds tens of billions in our greenback as a reserve, and for use in global trade. When the USD is strong, foreign investors have an incentive to convert their local currency into US dollars, which they do via investments in our stocks and bonds. The chart below illustrates how periods of a strong U.S. dollar have coincided with U.S. stock market outperformance. Conversely, notice how international markets start to outperform when USD has been in a downtrend:
After hitting a multiyear peak in March 2020, the USD has fallen 10%. That is a considerable drop for the USD, relatively speaking. Not surprisingly, during this time foreign stocks outperformed U.S. stocks for the first time in several years (but to be fair, our stock market did quite fine as well). The best-performing stock markets in the world last year were in China, Taiwan, and South Korea, all up about 40%.
International stocks are “cheaper” than U.S.
Also, as a result of several years of underperformance compared to U.S. stocks, international stocks now have valuation discounts to the U.S., (based on forward Price/Earnings estimates for 2021), as shown in the chart below:
A key reason for the lower valuations abroad is that most foreign stock indexes are weighted towards “value” stocks, such as banks, industrials, energy, materials, and commodity stocks. In contrast, the S&P 500 is increasingly dominated by so-called, “mega-cap growth” stocks – Apple, Microsoft, Facebook, Amazon, and Google. In fact, those five stocks alone accounted for about 90% of the total return of the S&P 500 last year. So far this year, the five big tech stocks are collectively struggling while value stocks are surging higher.
International ETFs we own
We are watching for the valuation discounts abroad to dissipate in the form of strong international equity performance. We believe in the strength and the runway of the whole global economy, which is why we retain 20-30% allocations to international and emerging markets via ETFs like VEA, VWO, SCZ, EWY, EWT, and others. We also are attracted to the higher dividend yields that can be found overseas, as the yield on the S&P 500 has fallen to about 1.5%, down from above 2% for several years prior. We also believe President Biden will be seen as more amenable to global trade deals and diplomacy efforts compared to his predecessor.
There is such a wide variety of low-cost ETFs that offer exposure to international stocks – it’s truly never been easier, or more cost-effective, to get a strong base of international equity exposure or to laser in on a specific region of the globe. Between a weaker dollar and the strong performance of value stocks around the globe, conditions could be ripe for international stocks to continue building on their momentum.
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