The U.S. stock market has sustained a scorching recovery run since April, pushing numerous major indexes to record highs. This has many investors considering alternative opportunities in other countries. Following a decade of steady gains and with economic uncertainty looming over the next 18 months, many investors fear that the current valuations are simply unsustainable. Much of the potential upside is already reflected in stock prices, and less dovish behavior from the Fed could eventually cause a pullback. Foreign equities are one potential solution for concerned investors.
Where can investor capital even go?
Soaring equity values are plain to see, but the appropriate reaction to those conditions is less obvious. Stock prices may indeed be sustained if the economy bounces back and monetary policy continues to provide support. Nonetheless, the balance between upside potential and downside risk has clearly shifted from where it stood in the first quarter, yet finding suitable alternatives is tricky.
Bond yields have cratered following sweeping action by the Federal Reserve, pushing prices higher in fixed income markets. Interest rates on savings accounts, certificates of deposit, and money market accounts also dropped. Gold has climbed nearly 37% year to date, raising concerns that the safe haven asset might have limited upside. Real estate has even seen surging demand as low interest rates stimulated buying activity, and people began leaving large, locked-down cities for the suburbs.
Forecasting the 2021 rebound around the world
An attractive option lies in global equities. The International Monetary Fund is forecasting 7.4% real gross domestic product (GDP) growth in the Asia Pacific and Southeast Asian regions for 2021. Projections for Australia & New Zealand are also bullish at 6.1%. These outpace the North American economies, which are expected to grow by 4.5%. Expansion rates in Europe and Central America are slated to be similar to the US, and Japan and South Korea are both expected to rise roughly 3%.
GDP growth does not correlate directly to corporate results, and even less so to equity prices due to fluctuating valuations, but it is still an important element driving investment returns over the medium and long term. Moreover, it provides a strong indication of the likely overall business environment in upcoming periods, which should heavily influence the rate at which stocks turn around from the recent market bottom. North America’s outlook is not superior to other important regions, but ETFs tracking U.S. equities have substantially outperformed those tracking several international indexes.
ETF Performance has diverged substantially
SPDR S&P 500 ETF Trust (NYSEMKT:SPY) has risen 6.9% year-to-date, and the NASDAQ composite index is flying even higher, up 27.8%.
While the forecast economic growth in the Asia Pacific region is much higher than that in the U.S, the iShares MSCI All Country Asia ex Japan ETF (NASDAQ:AAXJ) has only modestly outperformed the S&P at 7.3% this year. Further, that is way behind the U.S. tech stocks. Much of the ETF’s and region’s performance is dictated by China, but the contrast here is still stark. The Vanguard FTSE Emerging Markets ETF (NYSEMKT:VWO) is up only 0.8% on the year, despite developing nations having a superior outlook to the U.S.
Japan and South Korea are only supposed to lag North America modestly next year, yet iShares MSCI South Korea ETF (NYSEMKT:EWY) is up 3.7% YTD and iShares MSCI Japan ETF (NYSEMKT:EWJ) is actually down 1.8% YTD.
Australia, Europe, and global developed markets ETFs have been beaten down in the market, despite the likelihood of matching or exceeding economic growth in the U.S. next year. The Vanguard FTSE Europe ETF (NYSEMKT:VGK) is down 6.7% in 2020, iShares MSCI Australia ETF (NYSEMKT:EWA) has fallen 8.4%, and Vanguard FTSE Developed Markets ETF (NYSEMKT:VEA) has dropped 6.1% so far this year.
| ETF | Year To Date Return | Region | 2021 Real GDP Forecast |
|---|---|---|---|
| SPY | 6.9% | USA | 4.7% |
| AAXJ | 7.3% | Asia Pacific | 7.4% |
| EWY | 3.7% | South Korea | 3.4% |
| VWO | 0.8% | Emerging Markets | 6.6% |
| EWJ | -1.8% | Japan | 3% |
| VGK | -6.7% | Europe | 4.4% |
| VEA | -4.7% | Developed Markets | 4.5% |
| EWA | -8.4% | Australia | 6.1% |
Critics of these international plays would justifiably point to several risk factors that complicate the opportunity. Relatively high expense ratios are a drag on returns. Fears over trade wars or military escalation could have catastrophic consequences in select markets. Complications from future currency fluctuations can also dissuade investors. Moreover, the 2020 performance analysis ignores any valuation disparities that came into the year, and 2021 GDP forecasts fail to account for longer-term dynamics. Nonetheless, as enticing opportunities dry up, these less-favored equity vehicles deserve consideration as alternatives to richly valued US stocks.
