What’s the most common statement we hear when asking a group of U.S. investors about international equities? One unsurprising, yet common, response is: They always underperform the U.S. Over the last 15 years, that statement generally rings true. However, setting aside recency bias and zooming out just a bit further, international equities outperformed the U.S. for 7-years period during the early 2000s, as they have in other periods.¹
With U.S. clients increasingly looking to diversify exposures to historically expensive domestic equities, there are a number of reasons to look internationally.
Firstly, international equities look historically cheap, particularly versus their U.S. counterparts. Perhaps the valuation discount sounds familiar, yet the magnitude is not. International Equities now trade near a 40% P/E discount to their U.S. counterparts. Not only is this relationship at multi-decade extremes, but it’s only been seen once before in the late 1990s, directly preceding the multi-year period of international outperformance mentioned above.2
Aside from lower valuations, international equities offer currency diversification against the dollar’s decade-plus long bull market and exposure to differentiated high quality companies outside the U.S. Additionally, globally diversified revenue streams and a higher weighting to cyclicals means that international stocks stand poised to benefit from stronger global growth.
While the S&P 500 faces concentration risk, international markets offer ample stock-picking opportunities, with over 2000 stocks across 46 countries across large and midcap companies in the MSCI ACWI ex USA Index.3 Despite the vast opportunity set, counterintuitively, U.S. investors often view international equities as a single asset class or split them between Developed and Emerging Markets. We’d argue a more nuanced approach is needed, considering that in the last 3 years alone, the decision to invest in International Value would’ve yielded an additional 26% cumulatively relative to investing in International Growth.2
International Value: ‘Double Diversification’, performance in ‘normal’ rate environments
International Value combines two areas of the market which have been deeply unloved for a number of years. Why could this change? There are two particular dynamics which we feel cannot be ignored.
Clients tell us almost unanimously that they remain heavily exposed to both U.S equities and growth. Yet with valuations in U.S growth stocks looking increasingly high relative to history, conviction levels are declining. Naturally, clients are eager to explore ways to diversify this exposure. By complementing U.S growth with a position in International Value, clients are able to get twice the bang for their buck, diversifying by both region and by style – ‘double diversification’ if you will.
Considering the wide range of options in public equities, recent and long-term returns, and resulting correlations, indicate that diversifying U.S Growth exposure is most efficiently achieved through exposure to International Value. Take 2022 for example – in a year when the S&P 500 stuttered, falling by 18%, the MSCI EAFE Value index outperformed it by 16%, softening the blow for investors allocated to both.2
In our view, the interest rate back drop is a call to action for diversification. While growth stocks have enjoyed a long run bull market for a number of reasons, the decade-plus period of low/zero interest rates following the financial crisis played a supporting role. Low interest rates benefit growth stocks with longer duration earnings. Conversely, higher rates benefit value stocks that are generally more exposed to economic growth. Over the past 50 years, value stocks have never sustainably and continually underperformed growth stocks in international markets when rates have been at normal levels (i.e. greater than 1%). Unless we believe rates are going back to near zero – a scenario we find difficult to envision – the interest rate backdrop bodes well for a resurgence of value performance going forward.
International Growth: Discounted and diversified high-quality structural winners outside the U.S.
In markets, sometimes the good gets thrown out with the bad. We see this dynamic quite frequently when it comes to high-quality growth companies outside the U.S. The absolute best companies across the world are at the forefront of innovation, capitalizing on globally relevant, structural themes. Yet, if domiciled outside the U.S., they typically trade at a discount to a comparable U.S. company. For example, Novo Nordisk is the market leader in GLP-1 medications treating diabetes, the fastest growing disease globally. Despite Novo’s substantially higher 5-year revenue growth and return on invested capital (ROIC) versus U.S-competitor Eli Lily, Novo trades near a 40% P/E discount.2
In some instances, international investing provides exclusive access to companies with no equivalent U.S. competitor. Take for instance, European luxury goods, which encompass some of the world’s most sought-after brands. As a group, they benefit from the intersection of favorable demographic and wealth trends, offering exposure to the rapidly expanding global middle-class alongside less price-sensitive, wealthier clientele.
Lastly, with index concentration levels looking particularly exaggerated in U.S. growth, International Growth offers diverse and less concentrated exposures across stocks, sectors, and regions, as illustrated below.
Regardless of your strategy for international equity investing, J.P. Morgan Asset Management provides a comprehensive range of solutions for clients to leverage across the style spectrum.