Global equity markets were higher on the week, with emerging market stocks leading the charge. In the U.S., the S&P 500 Index rose to a level of 4,204, representing a 1.20% gain, while the Russell Midcap Index increased 1.23% for the week. Meanwhile, the Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, pushed 2.45% higher for the week. Moreover, developed and emerging international markets returned 1.24% and 2.39%, respectively. Finally, the 10-year U.S. Treasury fell to 1.58%, five basis points lower than the prior week.
Heading into 2021, market forecasters expected to see international equities take the lead relative to U.S. Large Cap stocks for the first time since 2017 (and 2012 before that). After vastly underperforming U.S. Large Cap stocks for the last decade, lagging in eight out of the previous ten years, international stocks have put up a valiant fight across the first five months of 2021 but still trail U.S. equities. Despite years of underperformance by international equities, a trend that has continued thus far in 2021, we still contend that international markets offer highly attractive valuations, which typically translate to above-average long-term returns. For context around the staggering performance gap between the U.S. and international equities, consider that the S&P 500 index has returned roughly 288% over the last decade, while the MSCI EAFE (EAFE = Europe, Australia, and the Far East) Index and the MSCI Emerging Markets Index have “only” returned about 82%, and 51% respectively.
The chart below, which was produced by Goldman Sachs, clearly depicts a substantially wide sector-adjusted forward valuation gap. In fact, two-year forward Price-to-Earnings (P/E) multiples indicate that developed international equities, as represented by the MSCI EAFE Index, trade at a discount of nearly 20% to U.S. equities, while emerging market equities, as represented by the MSCI EM Index, trade at a 32% discount to U.S. equities.
So, why should investors who have been rewarded for maintaining heavily overweight allocations to U.S. equities care about the divergence in forward valuation multiples between U.S. and international equities? Our research suggests that forward P/E ratios have been one of the most consistent indicators of a stock market’s average long-term return. As you can see in the J.P. Morgan Asset Management chart below, there is a direct relationship between a stock market’s forward p/e multiple and the average return an investor is likely to experience in the proceeding five years. Those who invested when the P/E multiple was at its lowest point generated average annual returns of approximately 20% per year. Conversely, those that invested when the P/E multiple was at its highest level produced negative average annual returns.
To be clear, we don’t advocate abandoning U.S. equities altogether as we are still optimistic about the future growth potential of U.S. stocks within the expanding U.S. economy. Still, we believe that the time for considering a more pronounced allocation to developed international and emerging market equities is now. Regardless, what’s most important is to remember that forecasts and expectations can disappoint (and have before), and one way to help protect against significant disappointment is to maintain a properly diversified portfolio based on each individual’s unique circumstances. As such, we encourage investors to stay disciplined and work with experienced financial professionals to help build and manage the asset allocations within their portfolios consistent with their objectives, timeframe, and tolerance for risk.
We hope everyone enjoyed a nice Memorial Day weekend and wish everyone a good week ahead!
Disclosures: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion and Walsh cannot guarantee the accuracy of said information and cannot be held liable. You cannot invest directly in an index. Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against a loss.
Other Data Sources: Equity Market and Fixed Income returns are from JP Morgan as of 5/28/21. Rates and Economic Calendar Data from Bloomberg as of 5/28/21. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index, U.S. Large Cap defined by the S&P 500. Sector performance is measured using GICS methodology. S&P 500 sector performance represents total return figures sourced from Bloomberg.
Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against loss.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than the original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.