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Market View

Why investors may want to include a blend of overlooked international equities and still-compelling U.S. stocks as the core of their long-term portfolios.

 

In Brief

  • Investors who have enjoyed healthy returns on U.S. stocks may want to add to their global exposure, as non-U.S. equities appear poised to make up lost ground on their U.S. counterparts.
  • Global equities, by their nature, present an immense opportunity set.
  • Analysts with deep industry expertise can develop truly differentiated insights when combing through nearly 50 different markets and 2,500 distinct companies.
  • Considering the breadth of that investable universe, it holds true that uncovering mis-valued securities is an inherently more repeatable skill than attempting to predict macro or geopolitical outcomes.

 

For the first time since 2012, international equities outpaced their domestic counterparts in 2017, as an uptick in global growth expectations and improving fundamentals led to renewed investor interest in non-U.S. equities. While U.S. equities have ridden a strong nine-year bull market since the market bottom in March 2009, the confluence of sovereign debt crises in the eurozone, slowing growth in China, and currency headwinds for emerging markets (among other factors) weighed on international equities in the wake of the global financial crisis of 2008–09, dampening investor demand during this period. With many of these challenges well behind us and international markets on a much sounder economic footing, international equities appear poised to make up lost ground on their U.S. counterparts. (See Chart 1.)

 

Chart 1. Think Global: International Equities Look Ready to Catch Up with Their U.S. Counterparts 
Percentage returns since the bottom of the global financial crisis in March 2009; 
S&P 500 Index compared with the MSCI ACWI Ex. USA Index


Source: Morningstar Direct. Past performance is not a reliable indicator or guarantee of future results. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment.  Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Investors may be wise to note that in addition to this wide gulf in total returns, international equity valuations today still appear very reasonable (the MSCI ACWI ex U.S. currently trades at a forward P/E of 14.1x), and the global growth expectations that drove investor optimism in 2017 have been ratcheted up further, with the International Monetary Fund projecting 3.9% growth for 2018 and 2019, following 3.7% growth in 2017. Yet investors who may believe the time is ripe for a full rotation into international stocks also may be wise to consider that robust corporate earnings and some early volatility in 2018 have driven the forward P/E on the S&P 500® Index to its most attractive levels since the beginning of 2017, while a manageable inflation picture and persistently strong domestic fundamentals are likely to provide continued support for risk assets in the United States as well. In short, we think it’s a very good time to be a global equity investor. As such, investors who have overlooked international equities in recent years, but still find U.S. stocks a compelling proposition, may want to consider global equities as the core of their long-term portfolios.

A Global Approach as the Core of Portfolios
Historically, allocating between U.S and international equities has proven to be a 50/50 play: in the last 18 calendar years, domestic and international equities have each outperformed the other exactly half of the time.

 

Table 1.  Timing International versus U.S. Equity Exposure Is Difficult
Since 2000, international and U.S. stocks have each outperformed 50% of the time


Source: Morningstar Direct. Past performance is not a reliable indicator or guarantee of future results. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment.  Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

In addition, using a global equity manager as a core element of a portfolio may help investors see that virtually no potential upside is missed, as many U.S. investors (even against their best intentions) maintain a home-country bias. According to Lipper, for example, of the more than $9 trillion allocated to domestic and international equities by U.S. retail investors, only 22% is invested in international stocks, even though they account for nearly half of the global market (international equities represent 48% of the MSCI ACWI today).

An Active, Research-Intensive Approach to a Broad Opportunity Set
Global equities, by their nature, present an immense opportunity set. The MSCI ACWI today is made up of nearly 2,500 constituent stocks across 47 countries. Given this vast spectrum, investors who want to access global equities may want to consider an active investment approach. Going back to the start of the twenty-first century, the median large-cap global equity manager (as measured by the Morningstar World Large Stock category) has outperformed the MSCI ACWI by more than 30% on a cumulative basis, underscoring how active managers have added value over the long term.

When delving deeper into above-average managers during this period, a few trends are apparent: notably that these managers tend to exhibit less tracking error and volatility than the category as a whole, and have demonstrated a slight advantage in their ability to protect portfolios during market declines, capturing just 91% of the downside in the MSCI ACWI. These metrics make the case for a fundamental, research-intensive approach, as successful active managers have tended to generate returns through stock selection rather than factor or regional bets (as exemplified by their lower tracking errors) and have done so in a risk-controlled manner.

Qualitatively, the scope of the investment universe also would suggest that a research-driven approach would be desirable, as analysts with deep industry expertise can develop truly differentiated insights when combing through nearly 50 different markets and 2,500 distinct companies. And, finally, over the long term, it also holds true that the uncovering mis-valued securities is an inherently more repeatable skill than attempting to predict macro or geopolitical outcomes, particularly when the breadth of the investable universe is much of the entire world.

Many American consumers are already spending significant portions of their disposable income on products produced overseas, whether they be cars, sneakers, or appliances. Given this worldwide interconnectivity, it is surprising that American investors have displayed such parochialism toward investing in international companies. If we are all global consumers, there is no reason why we also should not all be global investors, especially when the backdrop looks as compelling as it does today.  

 

Tracking error is the standard deviation of the difference between a fund return and its benchmark index return. It is a measure of is the volatility of a fund return’s in excess of its benchmark.

Downside capture is a ratio that measures a manager’s performance in down markets relative to a particular benchmark. A down market is one in which the market’s quarterly (or monthly) return is less than zero. For example, a ratio of 50% means that the portfolio’s value fell half as much as its benchmark index during down markets.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

The MSCI ACWI (All Country World Index) ex-U.S. Index is a subset of the MSCI ACWI Index.  The MSCI ACWI (All Country World Index) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI Ex-U.S. Index with Gross Dividends approximates the maximum possible dividend reinvestment. The amount reinvested is the entire dividend distributed to individuals resident in the country of the company, but does not include tax credits. The MSCI ACWI Ex-U.S. Index with Net Dividends approximates the minimum possible dividend reinvestment. The dividend is reinvested after deduction of withholding tax, applying the rate to non-resident individuals who do not benefit from double taxation treaties. MSCI uses withholding tax rates applicable to Luxembourg holding companies, as Luxembourg applies the highest rates.

IMPORTANT INFORMATION

Risks to Consider: Keep in mind that all investments carry a certain amount of risk including possible loss of the principal amount invested. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

No investment strategy, including diversification and asset allocation, guarantees a profit or protects against a loss. Stock markets, especially international markets, and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, industry, political, regulatory, geopolitical, and other conditions. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial.  Investments in smaller companies may involve greater risks than those in larger, more well known companies. Investments in international securities are subject to certain risks of overseas investing, including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations. These risks are magnified in emerging markets.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

No investing strategy can overcome all market volatility or guarantee future results.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

MARKET VIEW PDFs


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