Without a doubt, it’s been a frustrating few years for investors with a global orientation. From the end of 2009 through yesterday (12/6/12), total return for the MSCI World has trailed that of the S&P by about 12.5 percentage points. Of course, US stocks comprise nearly half of the MSCI World Index. Isolate the ex-US component as represented by the EAFE, and the story is even more ugly. EAFE returns have trailed over the past three years by nearly 25%! In the 11 full quarters since the end of 2009, the MSCI World and EAFE have only outperformed the S&P 500 three times. Here’s a table of quarterly returns:
MSCI World
|
S&P 500
|
EAFE
|
|
Q1:10
|
3.37%
|
5.39%
|
0.98%
|
Q2:10
|
-12.47%
|
-11.43%
|
-13.69%
|
Q3:10
|
13.92%
|
11.29%
|
16.57%
|
Q4:10
|
9.08%
|
10.76%
|
6.67%
|
Q1:11
|
4.93%
|
5.92%
|
3.50%
|
Q2:11
|
0.66%
|
0.10%
|
1.80%
|
Q3:11
|
-16.50%
|
-13.87%
|
-18.92%
|
Q4:11
|
7.74%
|
11.82%
|
3.40%
|
Q1:12
|
11.73%
|
12.59%
|
11.00%
|
Q2:12
|
-4.85%
|
-2.75%
|
-6.93%
|
Q3:12
|
6.84%
|
6.35%
|
7.00%
|
Q4:12
|
1.04%
|
-1.37%
|
4.24%
|
A funny thing has happened of late. For the first time since the end of ’09, the ex-US markets may outperform US markets for two consecutive quarters. The EAFE and MSCI World as a whole outperformed slightly in Q3:2012. Through yesterday, the EAFE has outperformed the S&P 500 by nearly 5.6 percentage points in the 4th quarter. Granted, there’s still plenty of time left in the month, but if things hold, this will mark the second biggest differential in performance between the EAFE and the S&P over the past three years (the biggest was an 8.4% point win by the S&P in Q4 of last year while Europe was struggling with most vicious news flow from the debt crisis).
What factors have started to perk up global performance relative to the US? Several issues could be at play. First, from a news flow standpoint, though negative headline flow in Europe continues as the continent struggles with economic weakness and the ongoing political drama surrounding the debt crisis, the intensity has decreased. Instead, global investors have found it’s the United States’ turn to absorb the brunt of negative headline flow as the President and Congress circle around the fiscal cliff issue. Plus, the US economy remains sluggish and US earnings growth has been less than inspiring of late. Second, the “herd” factor may be coming into play; individual and institutional investors entered 2012 with very negative sentiment towards ex-US markets. Accordingly, equity investors have parked significant capital in US relative to ex-US markets. As investors have voted with their feet in response to the debt crisis situation overseas, normalized multiples in overseas developed markets have become quite low relative to the United States, as we’ve discussed at several points this year. Coming into November, the US held the highest multiple among all developed markets around the globe as illustrated by this chart from the World Beta Blog:
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| Source: World Beta Blog, www.mebanefaber.com |
The US trades at approximately 21x. In contrast, the European or Asian developed market with the highest normalized multiple is Hong Kong at 17x, decently below the US position. The “Big 3” European markets, the UK, France, and Germany trade at 12.5x, 11.2x, and 13.4x respectively, far below the US. Most emerging markets remain at low multiples. Yes, economic/earnings and political conditions have been ugly overseas, especially in Europe. Using multiples as a guide, it’s apparent that markets have priced in significant pain, meaning that hurdles are low. When hurdles are low, it’s not particularly difficult to see a spark in performance with just the tiniest shift in news flow. The opposite is true as well. Hurdles are relatively high in the US and the tenor of news flow has been shifting, especially in earnings trajectory. As we discussed recently, earnings news disappointed investors last quarter in the US, which we believe contributed significantly to weak performance. Expectations are still reasonably optimistic for 2013 S&P 500 earnings. Another round of earnings misses could result in P/E multiple compression in the US.
Sum it all up, and it could be time for global equities to gain a little bit of the spotlight relative to the US. Global markets have underperformed US markets for quite some time. We’ve said it before and it will continue to say it: multiples revert to the mean for various reasons over time. It doesn’t necessarily happen quickly, and usually doesn’t happen in a neat, straight line. But it happens. There’s a wide chasm valuation-wise between US equities and global equities and that differential has developed over a long period of time. We continue to expect that this course of events will reverse sooner rather than later. Perhaps, the past two quarters of performance provide some indication that the ship is making its turn.
We’ll leave you with one final visual representation of the performance differential between the S&P 500 the MSCI EAFE that shows where market currently stand and how the relationship has shifted over time.
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| Source: IronHorse Capital |
