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Why Now is not a Good Time to Sell International

StratiFi Technologies Inc

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After a nearly 14% gain in the first four months of the year, the MSCI EAFE index slogged through a 3% decline in the month of May, triggering concerns by advisors that it may be over for international stocks. Our initial response to those concerns is any mention about one-month performance doesn’t really belong in serious conversations about investment strategies. It only feeds into the misplaced focus on short-term results, which can hurt long-term portfolio performance.

Advisors Feeling the Heat Over International Performance

However, in fairness to advisors, their concerns are mostly in reaction to the feedback they are getting from anxious clients questioning whether it might be time to throw in the towel on international stocks. Many have been in international for eight, nine, and 10 years and, after a down month, it’s killing them that their portfolios are not reaping the full benefit of a historic bull market in U.S. stocks.

Yes, U.S. Stocks Have Outperformed International – But is it Sustainable?

The fact is, it’s a great time to be a U.S. investor in non-U.S. stocks. International equities have done pretty well over the last eight years. When viewed in local currency since 2011, developed markets haven’t had a negative year until 2018. So it has primarily been currency issues at play here.

While international has actually been a pretty good equity market, it pales in comparison to U.S. stocks. But, considering that the U.S. market is in the late stages of a double run over the last decade – running at a rate twice what it normally does – would you be willing to bet that it continues?

Headwinds have Stunted International Performance

So, why have international equities been underperforming? When you consider all the headwinds international markets have had to contend with, it’s actually a wonder how they have performed as well as they have.

Number 1: Nearly every metric – price to earnings, price to book, price to cash flow, and dividend yield – clearly indicate international stocks are the cheapest values they’ve ever been.

And, at about 4.6%, dividend yields on international stocks are at an all-time high. The spread between international and U.S. dividend yields is the widest it has ever been. 

Number 2: Most all major currencies are undervalued to the dollar – some at historic lows. The British pound is at a 40-year low to the dollar. Of course, as a U.S. investor, that kills your performance. Are you willing to bet that all those currencies are going to remain undervalued? 

Morgan Stanley says the dollar is going to get weaker and there are many reasons why:

  •  Current U.S. GDP growth has been boosted by a one-time tax cut
  • Likelihood of fed rate cuts due to softening U.S. and global economy
  •  U.S. deficits and uncertainty over future reserve currency
  •  Gridlock in U.S. Congress

When the dollar does weaken, it turns a headwind into a tailwind.

Number 3: The uncertainty surrounding Brexit has dampened business for companies operating in Europe. Once the Brexit cloud clears, international trade should normalize and currencies should strengthen.

Getting Back to Why You Own International Stocks

With a clear view of why international has underperformed, it’s time to take a step back and remember why you own it. Essentially, the same reason for telling your clients to buy international still exists today – diversification. But the case may be even stronger today.

International companies comprise almost one-half of global market cap and about three-quarters of all listed companies. Owning long-term positions with well-diversified exposure across individual companies, countries, industries, and underlying currencies can provide far more growth opportunities than are presently available in U.S. markets. It can also provide greater protection from headline and macro risks.

The bottom line is, if you only own U.S. stocks, you may be drastically under-diversified.

If You Were Investing Today

With U.S. equity valuation reaching new highs each month, international equities have become much more compelling for growth potential for these reasons.

  • While U.S. markets have already priced in positive expectations for pro-business policy reform, international markets are still in the early stages of recovery after an extended period of underperformance.
  • The European Central Bank is still two years behind in its quantitative easing efforts, which should continue through 2020.
  • There’s no inflation and the EU is still issuing debt with negative yields.
  • The EAFE is near its deepest discount to U.S. stocks in 20 years.
  • With continued low-interest rates and low inflation, non-U.S. GDP growth has great potential to catch up to U.S. GDP growth.

Global diversification may actually increase return opportunities by better managing risk/return tradeoff. Not to mention that, generally, foreign equities may be more attractively valued than U.S. equities in light of the significant run up in the US stock market.

So, if you were looking at this for a new investor, is there any compelling reason why you wouldn’t consider international stocks? How would you compare the opportunity in international versus the opportunity in U.S. stocks? Do you tell your clients to skate to where the puck is (in U.S. stocks) or do you skate to where the puck is going (International)?  We can’t know when the puck is going to get here, but it is more likely to be here than in the U.S.

Finally, if you’ve been in international all this time, is now really the time to get out?

Getting Your Clients Over the Hurdle

Given a clear perspective of this big picture, experienced advisors know the answers to these questions. They know it’s not the right time to sell international and that the time to buy U.S. stocks was five years ago.

The sticking point is their clients, who, without such a clear perspective, tend to emote their concerns, often pressuring their advisors into taking actions to appease them. Remember your primary job – keeping your clients from doing the wrong thing at the wrong time and helping them stay focused on their long-term objectives. That is your true value as an advisor.

Share your perspective, ask these key questions. They’ll find the right answers. 

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Akhil Lodha Author
Co-founder & CEO StratiFi Technologies

Building the industry standard for understanding portfolio risk through cutting-edge technology at StratiFi.

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