A Long View of Non US Stocks

For what feels like the first time in forever, foreign stocks are outpacing US stocks so far this year.  The table above includes the MSCI All Country World exUS index, which combines all developed and emerging markets.  As of Friday, the MSCI ACWI is outperforming the S&P 500 by 1.79 percent.

That contrasts with the results over the last five years ending in March, when the S&P 500 earned 13.3 percent while the MSCI EAFE index of developed markets only made 6.28 percent.  That’s not great, except when you look at the MSCI EAFE Emerging Markets index only gained 1.14 percent.

Given the relative underperformance of nonUS stocks over the past five years, a lot of clients have asked us whether they still make sense, so we’ve been delving into the data.

Recently, we subscribed to some new data sets from Global Financial Data (GFD) that specialize in historic market data.  They have economic data going back to 1168, so the equity indexes that date back to 1693 seem downright new.

We were most interested in the developed and emerging market indexes that go back to 1926, when the good US data starts.  The nonUS data isn’t as high quality, but it’s reasonable and better than nothing.

Let’s start with a growth of a dollar, invested in the S&P 500, the GFD developed and GFD emerging market indexes (which both convert to MSCI in 1970).  What we see is interesting, in my opinion.

The US is the clear winner, which isn’t a surprise given some of the other research that’s out there (my favorite, which I’ve written about here, comes from Dimson, Staunton and Marsh).

The three indexes had fairly similar performance prior to World War II and as you might expect, losing a World War hurts returns, which set back the developed markets by 50 percent at the time.  The multiple lost decades in Japan since 1989 haven’t helped the developed markets either.

Still, it is interesting to see that stocks, US, developed or emerging, all handily outpaced cash, bonds and inflation.  Looking at the entire data set, US stocks have earned about 10 percent, emerging markets stocks about nine percent and developed market stocks about eight percent.

Interestingly, and to my surprise, the developed and emerging stocks endured lower volatility than the US markets.  I automatically think that emerging market stocks are riskier (and still do despite this data), but if the data is to be believed, emerging market stocks have had annualized volatility of 19 percent, compared to 21 percent for the S&P 500 and 17 percent for the developed markets.

The only explanation that makes sense to me is that the US is one market, whereas the other two are each made up of many indexes.  I’ll have to look through the data more carefully and read through some of the research before I change my mind on anything.

Our equity allocation is a mix of 75 percent US (but well beyond just the S&P 500), 20 percent developed markets and five percent emerging markets.  This mix earned as much as the S&P 500 over the full period, but with lower volatility than S&P 500, which results in a better risk-adjusted result.

We haven’t enjoyed the benefits of this diversification over the past five years, unfortunately, but looking at this data, I can tell you that this period was outside of the norm, but not completely unique either.

My calculations show that the five year rolling relative performance of the S&P 500 versus the developed index falls in about the 70th percentile, meaning that 70 percent of the time, the outperformance of the S&P 500 wasn’t this substantial.

Of course, that means that 30 percent of the time the S&P 500 did even better than the developed markets.  In the five years that ended in March 1946, for example, the S&P 500 gained 21.67 percent per year, while the developed markets index lost -14.40 percent per year.  As noted above, losing a world war is bad for returns.

At the other end of the spectrum, the developed markets index outpaced the S&P 500 during the five years that ended in April 1988.  The S&P 500 did well, earning 14.15 percent per year, but not as well as the developed markets index, which gained 36.13 percent per year.  Of course, that was just before the bubble in Japan was burst, which probably explains most of the outperformance.

In any case, as I look through this data, I’m more committed than ever to global diversification.  We definitely tilt towards the US, but I can’t get behind abandoning all of the other markets around the world – especially since they make up about half of the world’s value at this point.

I’ll be sifting through this data more in the coming months and hope to have more for you.  In the meantime, I’ll cross my fingers that all equity markets do well.