Might international stocks be entering a sustained period in which they outperform U.S. equities?
Investors have been asking this question for years, of course. I'd be a rich man if I had a dollar for every time over the past 30 years such a forecast was made.
So far, of course, those forecasts have all failed. In fact, as you can see from the accompanying chart, international equities have fairly consistently lagged the S&P 500 since the late 1980s -- but for two brief periods in the early 1990s and the early aughts.
Why might this much-anticipated turnaround finally be at hand?
One reason is relative valuations. Consider the Cyclically-Adjusted Price-Earnings ratio, or CAPE, which is the valuation indicator made famous by Yale University finance professor (and Nobel laureate) Robert Shiller. The S&P 500's CAPE currently stands at over 30, compared to 24.8 for "developed markets," 18.9 for "developed Europe," and 15.3 for "Developed Asia-Pacific." (These categories and calculations are courtesy of Star Capital.)
Because of these relative valuations, a number of well-respected firms are now forecasting that international stocks will beat domestic equities by margins that, if they come to pass, would be some of the largest in decades. Research Affiliates, for example, the Newport Beach, CA-based money management firm, is forecasting that the EAFE will outperform the S&P 500 by 4.8 annualized percentage points over the next decade. GMO, the Boston-based firm, is projecting an annualized alpha over the next 5 to 10 years of 3.9 percentage points.
Of course, valuation is a long-term indicator, providing little guidance for the short term. But there is some technical evidence that the tide may be turning, in the form of mutual fund relative strength rankings.
Consider a ranking of 800 no-load mutual funds based on their risk-adjusted performances, as compiled by Stephen McKee, editor of the No-Load Mutual Fund Selections & Timing Newsletter. He reports that more and more international stock funds have started to move up in this ranking. In fact, he reports, one of every six of the funds in the top 5% are now international equity funds.
McKee suspects this could be a "precursor" of international stocks outperforming the U.S.
(Disclosure: McKee is not one of the advisers who has contracted with my auditing firm to track his investment performance.)
Another factor that would contribute to international equities' relative strength is weakness in the U.S. dollar relative to foreign currencies. Dollar weakness, of course, boosts the U.S. dollar equivalent return of foreign equities.
Several of the analysts I monitor are projecting dollar weakness because, in effect, they believe foreign currencies can't go much lower than they already are. That's because so many of their issuing countries' central banks have already reduced interest rates to below zero and therefore have little leeway to cut further. The U.S., in contrast, with higher nominal interest rates, has further to go in possibly cutting rates, which would almost certainly cause the U.S. dollar to fall relative to foreign currencies.
Assuming you might be interested in increasing your international equity exposure, below are three funds in that space that currently are recommended by at least one of the top-performing newsletters I monitor: