US vs. International Stocks

Barring a collapse in the S&P 500 or an absolute moonshot in the MSCI EAFE over the next week and a half, the S&P will have outperformed the EAFE (international developed markets) in four out of the last six years, with last year essentially a draw (the performance differential was 0.15%).  As of 12/19, the S&P 500 is up 26.9% YTD on a price basis excluding dividends.  The EAFE is up 15.7%.  

Since the financial crisis in the US morphed into a sovereign debt crisis on the European continent, money directed towards equities has flowed decidedly towards US stocks.  While international flows of late have perked up with European and Asian developed economies, there’s still a long way to go to bring US investors back into a mindset that international can enhance portfolio returns over time.  

We thought we would look at the recent and overall history of returns out of general interest and to perhaps provide some color on where performance will come from in the future.

First lets look at some quick overall and relative performance statistics for the S&P 500 and MSCI EAFE:

Annual Performance Statistics:

	S&P 500		EAFE
Average Annual Past 10 Years	6.67%		8.21%
Average Annual Past 20 Years	7.86%		6.05%
Compound Annual 5-Yrs Trailing	-0.58%		-6.57%
Compound Annual 10-Yrs Trailing	4.95%		5.35%
Compound Annual 20-Yrs Trailing	6.11%		3.88%
Compound Ann. 1970 to 2012	6.58%		6.67%
St. Deviation of Returns 1970 to 2012	16.98%		22.09%

Relative Performance: Highlighted Numbers = EAFE Underperformance:

2012	0.15%
2011	-14.82%
2010	-7.88%
2009	4.29%
2008	-6.60%
2007	5.09%
2006	9.85%
2005	7.86%
2004	8.60%
2003	8.90%
2002	5.85%
2001	-9.57%
2000	-5.07%
1999	5.74%
1998	-8.44%
1997	-30.77%
1996	-15.87%
1995	-24.69%
1994	7.78%
1993	23.44%
1992	-18.35%
1991	-16.12%
1990	-18.15%
1989	-18.03%
1988	14.26%
1987	21.16%
1986	52.18%
1985	26.64%
1984	3.62%
1983	3.64%
1982	-19.39%
1981	4.88%
1980	-6.76%
1979	-10.50%
1978	27.85%
1977	26.12%
1976	-19.51%
1975	-0.35%
1974	4.12%
1973	0.55%
1972	17.66%
1971	15.35%
1970	-14.23%

The first thing that comes to mind is that relative performance between US and International developed equities has been somewhat streaky since 1970.  As mentioned above, the S&P 500 has been the relative performance winner of late, but prior to 2008, the EAFE actually outperformed the S&P 500 for six straight years.  The EAFE streak ended a late 1990s, early 2000s streak during which the S&P 500 outperformed six out of seven years.  The pattern continues in similar form all the way back to our first year of EAFE data in 1970.  

Second, the annual performance numbers, especially the compound performance numbers for the trailing 10 and 20-year periods, were surprising.  For the 10-year period, many in our industry would probably say if asked in a blind test that the US has outperformed on a compound annual basis over the past 10 years, most likely due to recency bias.  After all, the 2008 to 2012 period breaks overwhelmingly in favor of the US.  Instead, the EAFE has actually outperformed by nearly 0.50% per annum over the past decade.  The average yearly performance differential is even greater in the EAFEs favor.  Looking at the trailing 20-year period, we would’ve expected the annualized numbers to track more closely owing to the long time period and the general performance convergence over long periods of time among various equity markets.  The US has outperformed by approximately 2.25% per annum over the past two decades, a very big difference.  

Demonstrating the convergence over long periods of time, when the time period extends the 43 years back to and including 1970, performance between the two indices is almost identical, with the EAFE winning by a nose.  Keep in mind the S&P 500 annual gyrations have been less pronounced as the S&P 500 standard deviation is much lower than the EAFE’s.  Gyrations in EAFE performance owing to the Japan bubble in the late 1980s and the collapse in the early 1990s probably explain a good bit of that differential.  

As with many of our other posts, we’ll tease a few takeaways from this data jumble:

First, over the past four decades, US and International (developed) equity market performance was essentially the same.  We have no reason to believe this will be materially different over coming decades.  While the US and International equity indices will continue to have their respective “days (or decades) in the sun”, performance over longer time periods between the two should be somewhat similar.  Ultimately, investors should benefit with a diversified approach across regions and borders as broader diversification should keep portfolio volatility in check.  

Second, conventional wisdom on the street for the past few years fell in the camp that the US represented “the cleanest shirt in a dirty closet.”  This attitude remains in place, in our opinion.  Flows in recent years show that investors have voted with their feet—much of the money committed to equities in recent years seems to have flowed towards the US.  With the European crisis dying down and overseas economies beginning to show some signs of life, flows and sentiment could change quickly.  At present, the EAFE is trading at approximately 17x earnings using a CAPE based upon Bloomberg’s adjusted earnings figures, adjusted for inflation.  In contrast, US Stocks are trading at approximately 21x.  Using a simple valuation model, predicted annual, nominal returns for the US (ex-dividend) are approximately 5.7% for the next decade and 6.2% for the EAFE.  Taking valuation, flows, and sentiment into consideration, we think there is a decent probability that the EAFE indices could resume outperformance in coming years. As we’ve pointed out numerous times on these pages, the historical performance record often shows that “what Wall St. knows ain’t worth knowin’.”