The Cyclicality between International and U.S. Equities and Why Now Could Be a Good Time for International (Pt 1 of 2)

December 19, 2018

The underperformance of international equities in 2018 has been dramatic. Through 11/30/18, international stocks (MSCI ACWI Ex USA Index) were down roughly -10% while U.S. stocks (S&P 500 Index TR) were up about +4%.

LMCG Blog #5 Chart #1-1

Source: Morningstar Direct

There are many reasons for this performance dispersion. Fueled by corporate tax reform, the U.S. economy continued humming along, with strong corporate earnings overshadowing the Federal Reserve’s hawkish interest rate policy. While international equities had been moving more-or-less in lockstep through the spring, a considerable disconnect occurred in mid-May, as shown in the graph above. Political uncertainty in Italy and the surprise formation of a coalition Italian government rattled European markets, and rising trade tensions with the U.S. have contributed to the instability. Emerging markets have been hit especially hard by the strong U.S. dollar, which has had ripple effects across global markets. As the dollar increases in value, this makes it more expensive for some emerging market countries to service their dollar-denominated debt.

Taking a step back, U.S. stocks have been outperforming their overseas counterparts for a longer period of time than many investors may realize. As shown in the graph below, U.S. stocks have outperformed international stocks throughout the post-financial crisis period. This is especially true since 2011, which was a tumultuous calendar year where the S&P 500 Index experienced a drawdown of over 15%, only to recover and end the year roughly where it began. International equities, on the other hand, took over two years to regain those losses.


Source: Morningstar Direct

Looking at the data a bit differently, we can see below just how massively U.S. equity has outperformed the world since the Global Financial Crisis. U.S. stocks have outperformed International Developed stocks by roughly +179% and Emerging Markets by +155%.


Source: Morningstar Direct

But the underperformance of international equities has not always been the case. During the market cycle between the last two recessions - the dot-com bubble and the beginning of the financial crisis (roughly 2002 - 2007) - foreign stocks outperformed domestic stocks by an astonishing margin. This included outperformance in every calendar year during the period, as shown in the graph below. In five of these six years, the excess returns of international equities neared 10% or greater. Part of this was driven by extremely strong economic growth in emerging markets, but developed international markets also performed well.

Calendar Year Performance

Source: Morningstar Direct

With current concerns around rising interest rates and peaking earnings in the U.S., it isn’t hard to imagine another prolonged period of outperformance by overseas stocks, especially considering the historically-cyclical relationship between the two asset classes. We look forward to providing more data around this hypothesis in an upcoming blog post.



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