President Donald Trump’s pledge to make America great again has helped drive US stock prices to new all-time highs in recent weeks. The newly-elected President’s outspoken demeanour combined with soaring business confidence have stoked hopes for a more prosperous country — adding yet another leg to an extended risk rally which has made the major US stock indices among the world’s best performers. Recently, however, global equity markets have been telling somewhat of a different story and investors should pay attention.
Since the beginning of the current bull market, which started in March of 2009, the US-based S&P 500 has advanced by a total of 250 per cent, leaving most other countries in the dust. Over the same period, European markets as measured by the Stoxx 600 index are up 131 per cent, Asian markets have climbed by 129 per cent and Emerging Markets increased by just 109 per cent, or less than half the gain of the S&P.
However, for the first quarter of 2017, the S&P 500 has lagged other developed markets by 1.32 per cent and has fallen behind emerging markets by 5.38 per cent as the so-called “Trump Trade” began to fade around the beginning of March. Could this be the beginning of a secular rotation?
Over the long haul, the US has been a strong performer relative to other countries, but this has not been case for every single year. A closer look at US versus non-US investment returns clearly shows some cyclicality. Over the past 45 years, we have seen six intervals of US outperformance, but also six periods of underperformance based on rolling three-year average investment returns.
For this study, the S&P 500 is used to represent the US while the widely-followed EAFE index, which stands for Europe Far East and Australasia, is used to represent the other developed country markets. Since 1972, the US has outperformed the EAFE approximately 55 per cent of the time on a rolling-return basis. But looking at individual annual returns the EAFE has actually outperformed the S&P 500 23 out of 45 years, or slightly more than half of the time.
The longevity of the present move is also worth considering. On average, US market outperformance has lasted approximately 50 months during its growth spurts. Yet the current period of outperformance has lasted 88 months, making it the longest rolling three-year outperformance period over the past four-and-a-half decades.
On the surface, some level of investor favouritism makes sense. US profit growth has been better than average in recent years while Europe, Japan and many of the emerging market countries have struggled with significant geopolitical issues. The European debt crisis, Japan’s deflationary headwinds and decelerating growth in China have kept American investors on the sidelines with respect to overseas equity allocations. Over time, geopolitical events tend to balance out though, and international stocks now look cheaper now on a relative basis.
Robert Shiller, the Nobel Prize-winning economist, popularised the concept of measuring market valuations by using cyclically adjusted price/earnings (Cape) ratios. By this measure, the US is presently trading at a relatively lofty 25 times earnings, while international markets in the aggregate trade at a somewhat more reasonable Cape ratio of 15 times earnings. Meanwhile, Emerging Markets trade at only about 11 times their Cape ratio. The US has historically commanded a premium to other markets but its present valuation is considered by some to be rather stretched.
At LOM, we have long admired America’s resiliency during these more challenging times and indeed have viewed the world’s largest economy as the “cleanest dirty shirt in the laundry bin”. But around the globe, other economies have finally begun to perk up and are quite possibly offering better value without the political uncertainty of what America’s new government may or may not be able to accomplish.
Recent economic reports suggest countries in Europe, Asia, Japan and Australia have finally stabilised and are growing again. An underlying trend towards a synchronised global economic resurgence is good news for countries overseas with spare resources, most of which, unlike the US are not yet raising interest rates. Stronger global growth is helping boost corporate profits in the eurozone, emerging markets and Japan.
Notwithstanding the challenging Brexit negotiations and potential for further populist backlashes, Europe appears to be on the upswing. The eurozone flash purchasing manager survey just rose to its highest level in almost six years with the composite PMI registering a healthy reading of 56.7. From this robust level, economists extrapolate a growth on the continent approaching two per cent, placing it within a half per cent of the consensus expectations for US forward progress. In a separate survey, unemployment in Germany, Europe’s largest labour market, fell to a post-reunification low of 5.8 per cent in March.
It is important to consider the difference between what has been commonly referred to as the “Trump Trade” versus a much broader global reflation trend, which actually started months before America’s election. Already, many of the Trump Trade stocks, such as infrastructure-related companies and banks have traded well off their highs as doubts grow about the President’s ability to fulfil his campaign promises. At the same time, Europe and many parts of Asia are continuing to improve and certainly the better economic picture across these countries cannot be attributed to confidence in America’s political leadership.
Investors disappointed by the underperformance of more globally-positioned equity investment funds compared to the S&P 500 should not be discouraged. International allocations still provide important diversification benefits for US dollar-based investors, including most Bermuda residents. A reversion back to historical long-term averages could also provide meaningful additional investment returns if the trend continues.
Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.
This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority