Don’t Stop Believing: The Case for International Equities

Author: David Ruff
Date: March 12, 2015
Category: Emerging Markets
Tags: , , , , , ,

Diversification is an important element to a portfolio, adding a significant measure of risk management. Because of our strong belief in this philosophy, all the portfolios my team manages are diversified not only by U.S. and non-U.S., but by sector, country and market cap as well.

International stocks are overdue to perform
Given the recent bull market in U.S. equities, investors might think, why not allocate all my assets to the S&P 500 Index? While this is an understandable reaction, history shows us that this is not the best way to position a portfolio. A quick look at historical returns, shown in the table below, is enough to remind us that this outperformance will not last forever. Non-U.S. markets will eventually pull ahead, causing U.S. stocks to underperform for some period of time, and if all your eggs are in one basket, your portfolio will be poorly positioned. Since 1970, the average time span of outperformance by either market is 3.7 years. U.S. equities have been outperforming international markets for over five years now, making this the longest period of underperformance by non-U.S. equities on record. It is also the second largest magnitude of non-U.S. equity underperformance, behind the period from 1994–1999. Even through these cycles of outperformance, overall annualized performance of non-U.S. and U.S. equities has been pretty comparable since 1970 (7.12% versus 6.97%). In reviewing this historical data, I think we can expect a reversion to the mean.


International equities are attractive now
Historical trends unfortunately don’t reveal much about exactly when international equities may once again outperform, but a variety of metrics, including yields, valuations and earnings, reveal international stocks to be attractive in the current climate regardless of their relation to U.S. equities. As shown in the chart below, dividend yields are higher abroad. Valuations also favor non-U.S. equities, with foreign markets trading at 45% to 50% discounts on a price-book basis. While profitability favors the U.S., non-U.S. returns on equity are also attractive. Earnings growth for Europe and Japan has overtaken the U.S. due to weakening in their currencies and lower oil prices will help foreign markets with greater hydrocarbon/commodity import exposure. These metrics highlight that it is unnecessary and even unfavorable to wait for outperformance as great opportunities exist in international equity markets right now.

Key Metrics: U.S. vs. Non-U.S.

Country Dividend Yield 3-Year Dividend Growth Rate Price- Book Price-Earnings Enterprise Value/ EBITDA Latest Earnings Growth5 Return on Equity
U.S.1 2.02% 18.8% 2.7x 17.6x 11.1x 7.4% 23.1%
Non-U.S.2 3.19% 16.5% 1.5x 15.0x 8.4x 4.9% 17.3%
Non-U.S. Developed3 3.33% 15.6% 1.5x 16.2x 8.7x 17.2% 16.8%
Emerging Markets4 2.67% 20.6% 1.4x 12.1x 7.5x -7.2% 18.3%
Sources: Morningstar, HFR and Forward, as of 01/15/14
Past performance does not guarantee future results.1 Based on iShares S&P 500 Index data
2 Based on iShares MSCI ACWI World ex-USA Index data
3 Based on iShares MSCI EAFE Index data
4 Based on iShares MSCI Emerging Markets Index data
5 Latest earnings seasons quarterly earnings year-over-year growth, 10/15/14-01/15/15

The world isn’t black and white
Global diversification has become well-established as an essential tool in portfolio construction, but a binary approach that simply splits the world into U.S. and non-U.S. equities is an outmoded and unnecessarily unrefined way of allocating assets. Furthermore, oversimplifying many times doesn’t take into account the opportunities in emerging and frontier markets, which have more than doubled their share of the world economy in the last 20 years. Great dividend-paying companies can be found even in seemingly unfit markets, but it takes an experienced eye to seek them out. I believe it is most advantageous to leverage the knowledge of qualified investment professionals who can make discerning allocations based on individual factors, scouring global markets for specific types of opportunities regardless of macro factors. Rather than depending on simplistic formulas or index names, an active manager thoroughly analyzes individual companies on their merits.

Macro factors like the current outperformance by U.S. equities simply don’t tell the whole story. It’s important for investors and their advisors to evaluate many factors as they diversify their portfolios.

For more on this topic, read David Ruff’s new piece, International Equities: Another Turn of the Wheel.


Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

Foreign securities, especially emerging or frontier markets, will involve additional risks including exchange rate fluctuations, social and political instability, less liquidity, greater volatility and less regulation.

Asset allocation and diversification do not assure profit or protect against risk.

One cannot invest directly in an index.

David L. Ruff is a registered representative of ALPS Distributors, Inc.

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