2015 still young, but the tide has begun to turn
by Gregg S. Fisher Mr. Fisher founded Gerstein Fisher in 1993 with the pioneering vision of offering a quantitative investment management approach rooted in sound economic theory and more efficiently implemented through technology. Today the firm embodies that vision and continues to reflect Gregg’s commitment to ongoing research. Visit gersteinfisher.com. Reprinted with permission.
Early this year, many US investors were questioning the merit of investing in foreign stocks. Some even threw in the towel and sold their non-US holdings in the wake of a yawning gap in performance between US and international stocks.
For example, during the two years from Jan. 1, 2013 to Dec. 31, 2014, the S&P 500 Index returned 50.51%, which was 35 percentage points better than the MSCI EAFE Index of developed-country stocks and an astounding 55 points ahead of the MSCI Emerging Markets Index.
As my readers know, I’m a firm believer in global multiple-asset class investing—and I often caution investors against making investment decisions based on recent market history that is etched into their brains.
A Foreign Rebound
All of 2015 is not spoken for yet, but thus far the tide seems to have turned and foreign stocks have handsomely outperformed US large cap stocks, as depicted in Exhibit 1 below. Does this divergence surprise me? Especially in light of the continuation of the US economy’s relatively strong performance among developed nations and the slowdown in some key commodity-exporting developing countries such as Brazil and Russia, it does not.
Remember that stock market performance does not closely track economic performance. Rather, it is often more sensitive to the direction of economic change, shifting market sentiment and valuations than it is to current economic performance.
Let’s take the case of the eurozone. Its unemployment rate stood at 11.3% as of February 2015 (double the US rate), and heavily indebted Greece is still engaged in tense negotiations with its creditors. But, on the margin, investors seem to believe that the outlook has brightened somewhat—in March, the European Central Bank embarked on a $1 trillion-plus quantitative easing program and the sharp depreciation of the euro is stimulating the economic region’s exports and boosting the global revenues and earnings of eurozone-based multinational corporations (the MSCI Europe Index rose 6.94% year-to-date to April 15 in dollar terms and 21.86% in local currency terms).
Similarly, the cheaper yen has helped to juice Japan’s Nikkei index, which touched 20,000 in early April for the first time in 15 years. Compare this to the US, where a long list of American multinational companies has pared earnings forecasts for 2015 due to the effects of the strong US dollar (incidentally, one reason that US small stocks have outperformed the S&P 500 Index of large companies this year may be due to their lesser dependence on foreign sales and profits).
Even after this year’s rebound in foreign stocks, overseas valuations are still much lower than for US large stocks. For example, as of April 17, on a price-to-book basis, international developed and emerging market stocks were 41% and 45% cheaper than the S&P 500 Index, respectively.
Coping with Uncertainty
Some investors will attribute these steep discounts to the amount of uncertainty overseas. There is, in fact, always uncertainty, at home and abroad, which explains why long-term investors are compensated for taking risks in the form of risk premiums attached to risky assets such as stocks—bear in mind that risk and return are intimately related.
We follow events carefully, with key questions in mind—for example, when will the Federal Reserve Board start to raise interest rates, will Greece leave the eurozone, can the Bank of Japan succeed with its aggressive monetary stimulus in breaking the back of deflation in Japan?
But we make no attempt to predict the future, which we believe is not only impossible but also highly likely to be counterproductive to the results of long-term investors. Professor Rawi Abdelal of Harvard Business School, an academic partner to Gerstein Fisher, calls attempts to predict the future “a fool’s errand.” We agree. As Niels Bohr, Danish Nobel laureate in physics quipped: “Prediction is very difficult, especially if it’s about the future.” Since we are not omniscient or clairvoyant, we think it makes good sense, from both a risk and return perspective, to ‘hedge our bets’ by constructing carefully constructed global, rather than US-only, stock portfolios.
To be sure, in some years, such as 2013 and 2014, the diversified portfolio will trail the US one. But as our research repeatedly informs us, over long investment periods the globally diversified stock portfolio is highly likely to generate an equivalent or higher return with less volatility. Exhibit 2 compares two such portfolios during a 45-year period.
After an extended period of poor performance, foreign stocks have sprung back to life in 2015. Markets seem to be signaling that foreign markets, with their relatively low valuations, are somewhat less risky than previously perceived. An appropriate way to address uncertainty is to maintain a globally diversified portfolio of stocks.