International Markets – A Brighter Spot
We will be the first to admit that 2022 was a year many investors would like to forget. There were few places to hide with increases to interest rates pushing both equities and bonds down in the mid to upper teens (something US markets haven’t seen in the most recent 45 years).
Despite the difficult year, there were some brighter spots within portfolios that remind us of the importance of diversification, not just across asset classes (which admittedly, was not very helpful comparing equities to bonds) but across countries, sectors, and individual stocks.
US Dominance
Before 2022 it had been a challenging thirteen years for international markets. The US outperformed eleven of those years (international outperformed in 2009 and 2017) and during that time they outpaced international stocks by 415%.
Simply put, the US outperformed international by ~2.5 times in that time period.
Source: Dimensional Fund Advisors
Source: Dimensional Fund Advisors
Given the anemic relative returns for international markets, it has been an onerous task for many asset allocators to defend international stocks belonging as a portfolio staple. We addressed similar sentiment in our November 2019 blog (insert link) reminding investors that in the 1970’s, 1980’s, and 2000’s international stocks beat US stocks rather significantly before this recent 12-year US run began.
However, 2022 served as a helpful reminder to many as to why international stocks typically belong in a well-diversified and well-designed investment solution. While international markets were still down in 2022, thankfully they were down less (~14.3%) compared to the Russell 3000 and S&P 500, which ended the year down ~19.2% and ~18.1%, respectively.
Currency Headwinds
Some may look at 2022 performance and say, “big whoop - it’s only a 5% differential”, but looking underneath the hood of what drove international market returns is eye-opening.
More than half of the drawdown in international stocks was directed by currency exposure. Even with concerns about the US Dollar devaluing heading into 2022, we saw significant strengthening relative to the Euro and Yen. Returns for the same index in local currency were only down ~7%, coming in at almost a third of the drawdown seen by the Russell 3000. And in a year with interest rates rising and inflation spiking, international markets fared relatively well, fundamentally avoiding double-digit losses.
Valuations
Another interesting dynamic for international markets is their valuation ratios. Although valuations don’t tell the whole story they are a very important factor for communicating expected returns.
As we began 2022, valuations across international markets were significantly lower compared to the US.
2021 Year-End Valuations
| Price-to-Book | Price-to-Earnings | Price-to-Sales | Dividend Yield | |
|---|---|---|---|---|
| Russell 3000 TR USD | 4.22 | 23.90 | 2.92 | 1.19 |
| S&P 500 TR USD | 4.59 | 25.15 | 3.21 | 1.25 |
| MSCI World ex USA NR USD | 1.89 | 16.44 | 1.58 | 2.46 |
| MSCI EM NR USD | 1.84 | 12.49 | 1.53 | 2.45 |
*Data from Morningstar ending December 2021.
And despite beating the US in 2022, valuations across international markets still look attractive with Price-to-Book, Price-to-Earnings, and Price-to-Sales coming in significantly lower than US counterparts.
2022 Year-End Valuations
| Price-to-Book | Price-to-Earnings | Price-to-Sales | Dividend Yield | |
|---|---|---|---|---|
| Russell 3000 TR USD | 3.28 | 17.92 | 2.04 | 1.67 |
| S&P 500 TR USD | 3.59 | 19.03 | 2.26 | 1.72 |
| MSCI World ex USA NR USD | 1.58 | 12.55 | 1.28 | 3.25 |
| MSCI EM NR USD | 1.56 | 10.62 | 1.21 | 3.24 |
*Data from Morningstar ending December 2022.
And for investors who put a lot of emphasis on dividend yield (we tend to focus on total return), those metrics have a considerable delta between them as well.
As we wrote in our blog in 2019 (“Why Should I Invest Globally?”), there are also other benefits of keeping a global view:
International stocks increase the opportunity set for stocks from ~3,600 to 11,000+.
International stocks provide access to economic sectors that may have less prominence in the US (e.g. more financials and industrial, less technology and healthcare).
Global growth outlooks are greater for international than US.
And recently, international stocks have much more attractive valuations.
What’s Next?
Finally, we don’t know what will happen as we enter 2023. The US Dollar could continue to strengthen, and US stocks could have another year to hang their hat on relative to international counterparts. Thankfully, we are not in the business of guessing what will happen in the short term. We are in the business of building efficient portfolios in line with client goals, and for most individuals, this should include the diversification benefits (country, sector, valuation, opportunity set) that come from international markets.
