New Opportunities Ahead
“Man cannot discover new oceans unless he has the courage to lose sight of the shore.” – Andre Gide
Since 1988, U.S. equities have outperformed international developed equities 52% of the time. Three periods of U.S. equity outperformance stand out: 1) December 1988 through February 1993 and 2) July 1994 through March 2002, when the U.S. outperformed by 120% and 141%, respectively. Each period was followed by a year or more of underperformance. 3) During the last decade from December 2007 to April 2017, the S&P 500 Index outperformed the MSCI EAFE Index by 6.4% (annualized: see Figure 1). While history can’t predict the future, a reversal seems likely. When should we expect a reversal? No one knows.
Figure 1: Historical Trends Show a Reversal May Be in Order between U.S. and International Equity Performance (as of 5/30/17)
Source: Thomson Reuters Datastream, as of 5/30/17. Past performance is no guarantee of future results. An investment cannot be made directly into an index.
Notably, in retrospect, the highest equity returns were not always consonant with the region showing the highest GDP growth. Instead, valuations, shifts in risk appetite, and momentum usually provided better barometers for investment return.
A Switch in Political Risks
Investors and supporters of the European Union (EU) could breathe easy, as Emmanuel Macron edged out Marine Le Pen with 65% of the vote in the second and final round of the French presidential election. Macron’s victory, a decisive setback to nationalist/populist sentiment, has restored confidence in the EU and the Euro Project. Since the election, the euro has gained 2.1%.
Meanwhile, in the U.S., President Trump recently returned from his first trip overseas to a number of political challenges: FBI Investigators continue to probe various Trump/Russia connections, the new Health Care Bill faces delays from Senate lawmakers, tensions remain in Syria and in North Korea, and new tensions have arisen with NATO. Recent developments carry the risk of delaying the President’s economic agenda of tax cuts, reduced regulation, and infrastructure spending, while others pose concerns for risk assets and global trade.
The Case for Europe and International Equities
After a strong performance in recent years, U.S. equities now trade at a significant premium relative to other developed equity markets (see Figure 2). The forward price-to-earnings (P/E) ratio for the S&P 500 Index is 17.3, 12% above its 30-year average, while the forward P/E Ratio for the FTSE World Ex. U.S. Index reads only 14.5, 11% below its 30-year average.1
Figure 2: Valuations Look Attractive Outside of the United States
Source: Thomson Reuters Datastream, as of 5/30/2017.
European economies also appear to be gaining momentum, with the May Purchasing Managers’ Index at a six-year high, consumer confidence close to a 10-year high, and unemployment on a declining trend. We expect this should lead to decent European growth for the remainder of this year and next—the effects of which should continue to flow through to profit growth and capital flows. In the first quarter of 2017, profits of companies in Europe grew by 36% versus just 14% for the S&P 500.2 Analysts at FactSet expect European corporate earnings growth to decelerate slightly, but finish the year about 16% higher, compared to only 10% growth for the S&P 500. Meanwhile, the Euro region’s cheap currency and accommodative monetary policy underpin its attractiveness.
A switch in growth prospects and risks causes us to look beyond U.S. large-cap equities.
- The balance of risk and reward may have shifted in favor of international equities.
- There is a significant improvement in real economic data both at home and abroad.
- Political risks have shifted from Europe to the U.S., as the Trump administration faces some tough battles.
- We believe profit growth will be the primary driver of equity returns, rather than changes in valuation multiples.
- An upturn in relative forward earnings in Europe versus the U.S. should bode well for European equities.
Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
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Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability.
Valuation multiples is a valuation theory based on the idea that similar assets sell at similar prices.
Forward price to earnings (forward P/E) is a measure of the price-to earnings (P/E) ratio using forecasted earnings for the P/E calculation.
The S&P 500 Index is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Past performance is no guarantee of future results. An investment cannot be made in an index.
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.
The FTSE World Ex-U.S. Index includes approximately 2,200 stocks of companies in 46 countries, from both developed and emerging markets around the world.
The Purchasing Managers’ Index (PMI) is an indicator of the economic health of the manufacturing sector and is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.
The Euro Stoxx 600 Index tracks 600 publicly-traded companies based in one of 18 EU countries. The index includes small cap, medium cap, and large cap companies.
1. P/E ratios are measured against analyst forecasts for earnings over the next 12 months.
2. Source: Bloomberg, 5/30/17. Companies in Europe are represented by the Euro Stoxx 600 Index.
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