European Vacation
In the 1985 comedy “European Vacation”, starring Chevy Chase, the Griswold family wins a vacation tour across Europe where the usual havoc occurs. The movie’s Tomatometer score on Rotten Tomatoes is only 36%, with the critical consensus reading that it “…charts the course through a succession of pretty destinations, but the journey itself lacks the laughs…” This is an apt description if you look at the poor performance of European and international stocks versus U.S. stocks.
Dreary Data
I used the MSCI EAFE (Europe, Asia, and the Far East) index for international stocks. EAFE measures the return on large and mid cap equities across 21 developed market countries, excluding the U.S. and Canada. About 60% of the companies in the index are in Europe, with most of the remainder in Asia.
In chart 1 the total return of the EAFE is divided by the total return of the Russell 1000 index (which measures U.S. large cap stocks), with data starting in 1978. U.S. recessions are highlighted with the grey bars. EAFE is outperforming the Russell 1000 when the ratio is going up. You can clearly see that the ratio has generally gone down since its peak in the late 1980’s! The last good run of outperformance was from the early 2000’s into the start of the Great Recession in late 2007. Since then, however, the performance has been rotten with the ratio at the lowest level EVER. To put some numbers on it, since November 2007 the Russell 1000 provided an annualized return of 8.4%. EAFE eked out 1.3%. Not very funny when international stocks typically make up 25% of most investor’s equity holdings or 15% of a typical 40%/60% fixed income/equity balanced portfolio.
Chart 1
Source: MSCI, FTSE Russell, Morningstar, National Bureau of Economic Research
America Ahead
Reading my blogs on value, small cap, and emerging markets you have seen the same theme. U.S. large cap stocks have beat them handily for many years, in some cases a decade or more. Not surprisingly, it is no different when looking at the relative performance of international stocks. Chart 2 updates the chart from the emerging markets blog by adding the EAFE/Russell 1000 performance, the series shown in red. Red is a good choice, as EAFE has been the worst underperformer versus the Russell 1000 since 1987. Putting numbers on it, over the period shown the Russell 1000 delivered an annualized return of about 11%, and EAFE only 5%. I think that deserves an even lower Tomatometer score for EAFE than for the movie.
Chart 2
Source: MSCI, FTSE Russell, Morningstar, Fama/French
Portfolio Prognosis
The asset allocation for a portfolio should always be based off a financial plan. Once the strategic allocation to stocks is determined, it is prudent to diversify across countries and investing styles. How do we do that? While Chart 2 shows trends that are obvious in hindsight, I know from experience that it is hard to predict their direction. This is where history can help us out. I have shown in my market analysis blogs that the degree of underperformance of value, small cap, international and emerging market stocks is in statistically extreme territory. This tells me that I can tilt the odds of the market gods in my favour over a multi-year horizon by overweighting these stocks and underweighting U.S. large cap stocks.
Invest Wisely,
Dave Schaffner, CFA
Principal, Wayfairer Capital Management Ltd.
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2 Comments
Which do you think is most likely to happen first? Will the economy eventually catch up to the markets, or will the markets adjust to the economy?
The rule of thumb, based on history, is that the markets lead the economy, and I expect the same this time. We know that 2020 is different, in that the bear and bull markets we looked at since 1927 in the “History Is No Mystery” blogs were not associated with a pandemic. We aren’t finished with Covid-19 yet as the U.S. is still in its first wave and a second wave may yet be coming. However, what is also different this time is that we have seen the fastest and largest monetary and fiscal response to a crisis. It is rational for the markets to be much higher than their lows in March given this massive support. While the Nasdaq is now in positive return territory for the year, and the S&P 500 is only down single digits from its high in February, it makes sense that the values of other stocks that are more negatively affected by Covid-19 are still down significantly from their February peaks.