As a global research firm, one of the most common questions we get is how attractive international markets are vs US domestic stocks. The US has been on one of the largest bull runs since 2009 and the EAFE had mirrored the performance of US stocks up until the ‘European Crisis” in 2011. The US continued to enjoy strong growth with a little help from the fed while the international investment horizon was murky and difficult to navigate with each region having their own macro-economic set of issues.
We have learned through the financial crisis as well as the European Crisis that markets are aligned and we are truly in a global market environment. No longer is the question simply large cap vs small cap or growth vs value. If investors are trying to get the most alpha for their clients they would be negligent not to look across overseas at international securities not traded on US exchanges.
Before we begin to evaluate US vs International let’s first address US large-cap markets. US markets are within the normal valuation band and are fairly valued. Although there are industries and companies that are trading much like it was 1999 there are still a number of attractive investment opportunities.
As far as international markets, their valuation levels are far from a clear buy signal. However, what we are now seeing in international markets are monetary policies that mimic the QE programs in the US. Discount rates and risk have converged for international markets and we no longer see international markets as a clear risk environment compared to the US. Currently international markets have an implied discount rate of 100 bps in excess of those in the US meaning you are compensated for investing internationally with a 1% higher rate of return. With international policy providing the free flow of cash it would not be unrealistic to believe we should apply the same risk for US stocks as we do with their large cap international counterparts. In fact, roughly 40% of cash flow comes oversees from the top companies in the S&P500.
The Applied Finance Group evaluates economic performance and quality but valuation is the most telling when addressing attractiveness of a group of companies. By taking the median percentage upside of international stocks and netting out the median percentage upside of large cap US stocks we can conclude that this is a good time to invest internationally vs US stocks.