Through the second week of November, domestic stocks, as measured by t he S&P 500 Index, have returned a total of 26.7%. International stocks, as measured by the MSCI All Country World ex-U.S. Index have returned a total of 16.6%.1 Needless to say, there are very few unhappy equity investors out there today. This is a great time to discuss the performance disparity between the two with a clear mind, as it is less of an emotional burden when one has outgained the other rather than lost less than the other.

Starting with the most basic question: why should anyone invest in anything but U.S. stocks? “Past performance does not predict future results” is a popular phrase in our industry, and for good reason. While the U.S. has had the upper hand recently, it is important to remember this has not always been the case. In the ten years ending October 31st, U.S. stocks have outperformed their international counterparts. Alternatively, if one were to look ten years prior to that, internationals outperformed the U.S.2

As we climb the wall of worry headlined by recession calls, tariffs, Brexit and easing by the Federal Reserve of the U.S., it is important to remember that the last push before a changing of the guards tends to be a strong one. This year so far, one could argue such a “push” is being made in favor of U.S. stocks. With this in mind, how should investors proceed?

Valuation is the first stop. The difference between the respective price-to-earnings ratios against the average difference tells one story in particular. Over the past 15 years U.S. stocks have traded at a price-to-earnings premium vs. their international counterparts. The median of this premium is 0.85. The current price-to-earnings premium is 3.58.3 As shown in the chart below, this makes a simple case, on one valuation metric alone, for a possible reversal toward international outperformance due to richness in domestic shares.

Graph Source: Bloomberg Finance, L.P.

What is important to note here is that this is only one metric. Furthermore, this does not predict immediate or exact results. In any case, hindsight shows that investing in U.S. stocks over the last ten years has been the right decision for a perfectly “rational” human, whom, by the way, does not exist. Plus, the tug of war tends to be of a cyclical nature as international equities were the place to be at the turn of the century. There is one clear benefit to the diversified among us: international exposure dampens volatility through vast streams of earnings from unrelated companies and countries. This is the often underrated, “helps you sleep at night” effect.

If we could tell the future most would use it to their advantage. Looking forward, we can only estimate. It can be argued that there is more growth to be had overseas so the rest of the world, as a whole, can catch up to our standard of living, rule of law, and freedom to innovate. Will that growth materialize and be reflected upon with optimism? That is unknown. What can be observed is investor behavior. Safe havens are in demand. Investors are willing to buy negative yielding debt in fear of returns worse than a guaranteed and known loss. If incoming economic data suggests any sort of stability, the risk on trade will be revived and internationals, particularly emerging markets may recoup some recent underperformance. While this is only one small piece of the puzzle, we are starting to see convincing evidence that opportunity could be knocking overseas.

  1. Bloomberg Finance, L.P.
  2. Bloomberg Finance, L.P.
  3. Bloomberg Finance, L.P.