Global Strategy I: Follow the Money.
Joe and I have been advocating a “Stay Home” investment strategy for some time rather than a “Go Global” one. Late last year, we started dipping our toes into offshore waters. With the benefit of hindsight, we should have plunged right in. That’s what global investors have been doing over the past year, increasingly so since the start of the year. We would go with the flows for now—the flows of investment funds.
These flows may be increasingly driven by passive investors who are pouring cash into global ETFs. That’s not so obvious by looking at flows for US-based ETFs. Over the past 12 months through March, the ones that invest solely in domestic equities attracted a record $230.3 billion, while the ones that invest in equities around the world attracted $64.8 billion (Fig. 1). However, there were large outflows out of US-based mutual funds over this period, led by domestic funds with outflows of $163.4 billion compared with a $2.8 billion trickle out of world funds (Fig. 2). Altogether through March, US-based mutual funds and ETFs that invest in the US had net inflows of $66.9 billion, while those that invest internationally had net inflows of $62.0 billion (Fig. 3).
These flows aren’t big enough to explain the outperformance of offshore vs onshore equities. Clearly, investors around the world have concluded that the global economy is likely to continue growing for the foreseeable future without any major risks of a recession. Both world industrial production and the volume of world exports rose to record highs at the beginning of this year, up 3.0% and 2.5% y/y through February (Fig. 4 and Fig. 5).
Apparently, global investors have favored foreign stocks because they are deemed to be cheaper than US ones.
Consider the following:
(1) Major markets. Joe and I have observed that the forward P/Es of the MSCI stock price indexes for the UK, the EMU, and emerging markets (EMs) have been below the US valuation multiple since the start of the bull market (Fig. 6). (Japan has been cheaper since 2014.) It’s possible that investors are feeling that at current valuation multiples there is more risk in US equities than foreign ones, and are narrowing the valuation gaps (Fig. 7).
(2) All Country World. At the start of May, the US forward P/E was 17.8, while the All Country World ex-US was at 14.2 (Fig. 8). The ratio of the two was relatively high at 1.25.
(3) EMU & UK. At the start of May, the ratio of the forward P/E of the US and the one for the EMU (14.8) was 1.20. That is relatively high, but falling (Fig. 9). The ratio with the UK (14.3) is relatively wide currently at 1.24 (Fig. 10).
(4) Japan. The forward P/E of Japan has often exceeded, and sometimes matched, the one for the US (Fig. 11). However, since 2014, the US has exceeded Japan (now 13.9), with the ratio of the two currently at 1.28.
(5) EMs. The ratio of the forward P/E of the US to the one for the EMs (12.0 now) is currently at 1.48, which is quite high (Fig. 12).
(6) Forward earnings. You may be wondering what sparked the outperformance of the rest of the world over the past year. Obviously, one factor has been the widespread recognition that foreign equities are cheaper than American ones, as we just reviewed. Another important development has been the gradual tightening of US monetary policy, which started in late 2014 without triggering any serious problems for the global economy. Most importantly, forward earnings overseas, which had fallen sharply in late 2014 and throughout 2015, stopped doing so last year and has moved higher so far this year (Fig. 13).
Global Strategy II: No Contest.
Joe and I monitor the relative performance of the US stock market in our daily publication titled US MSCI Stock Price Index vs Rest of the World. We see that the ratio of the US MSCI to the All Country World ex-US MSCI peaked at a record on December 27, 2016 in US dollars and on June 16, 2016 in local currency. Now let’s drill down to the major equity market indexes abroad, comparing them to the US MSCI stock price index gain of 17.0% y/y and 6.9% ytd:
(1) Eurozone. The EMU MSCI stock price index has risen 23.7% y/y in euros and 19.6% in US dollars through Friday’s close. It is up 11.5% ytd in euros and 15.4% in US dollars.
(2) UK. The UK MSCI stock price index has risen 21.1% y/y in pounds and 8.7% in US dollars through Friday’s close. It is up 4.1% ytd in pounds and 8.6% in US dollars.
(3) Japan. The Japan MSCI stock price index has risen 18.5% y/y in yen and 13.5% in US dollars through Friday’s close. It is up 3.2% ytd in yen and 6.3% in US dollars.
(4) EMs. The EM MSCI stock price index has risen 21.7% y/y in local currency and 25.9% in US dollars through Friday’s close. It is up 12.2% ytd in local currency and 16.2% in US dollars. The EM MSCI currency index is up 5.5% y/y and 5.4% ytd.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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