Relative Return Review
Back in March of 2021, in my blog Springing Forward, I wrote about the performance of Canadian, international, emerging market, U.S. value, and U.S. small cap stocks versus the U.S. large cap stocks. After many years of underperformance, U.S. value and small cap stocks had finally started to outperform U.S. large cap stocks. But Canadian, international, and emerging market stocks were only keeping pace. A lot has happened in the markets in the two years since that blog with central banks raising rates to tame inflation and stocks enduring a bear market. So let’s review how the relative returns have evolved.
Short Term Relative Return Review
Chart 1 shows the relative performance of Canadian, international, emerging market, U.S. value, and U.S. small cap stocks versus U.S. large cap stocks using various market indices. The performance of each market is measured from March 2021 to January 2023 and is shown relative to U.S. large cap stocks.
Over this time period (which includes the bear market) U.S. large cap stocks, as measured by the Russell 1000 index, increased an annualized 1.6% for only a 3% cumulative return. The numbers on the far right of the chart show the relative outperformance or underperformance for the other stock indices. The light blue shading indicates the cold zone where the index return is less than or equal to the return on U.S. large cap stocks. All the returns were measured in U.S. dollars.
Chart 1
Since the March 2021 blog, the relative performance of U.S. value stocks (blue line) moved up from 1.0 to 1.13 by January 2023. This means that they continued to outperform U.S. large cap stocks by a total of 13%. However U.S. small caps (orange line) switched from outperforming to underperforming by 14%. Canadian stocks (green line) outperformed by 7%, while international stocks (red line) underperformed by 3%. And last, and definitely least, emerging market stocks (black line) underperformed by 20%.
Long Term Relative Return Review
The March 2021 blog concluded by saying there was limited room for U.S. small cap stocks to continue outperforming, and that certainly turned out to be the case. I also thought U.S. value, Canadian, international, and emerging market stocks looked promising over time. So far that has worked out well for U.S. value stocks and a little for Canadian stocks. But not so much for international stocks, and not at all for emerging market stocks!
But the time frame for looking at the relative returns is important, so let’s zoom out and look at them over the last few decades. Chart 2 looks at the relative returns since 1987, with the gray vertical bars highlighting when there were recessions. As you can see, U.S. large cap stocks have not always been the best performer. There have been long cycles of outperformance and underperformance. The biggest takeaway from Chart 2 is how cheap other countries’ markets are versus U.S. large cap stocks.
Chart 2
Relative Return Opportunity
There are many reasons why U.S. large cap stocks have delivered such a strong long term outperformance versus other countries’ markets. But one of the key drivers over the last ten years has been the increase in the value of the U.S. dollar. At some point, likely after the U.S. Fed stops raising rates, the U.S. dollar should end its upward March. This could be the catalyst that leads to Canadian, international, and emerging markets stocks getting their time to shine over the next decade. For long term investors, overweighting them in your asset allocation increases your odds of getting better returns.
Invest Wisely,
Dave Schaffner, CFA
Principal, Wayfairer Capital Management Ltd.