Morgan Stanley
  • Wealth Management
  • Oct 21, 2019

5 Reasons Non-U.S. Stocks May Start to Outperform U.S. Stocks

Going global hasn’t paid off for U.S. investors for the past 10 years, but this dynamic may be set to change soon.

Lisa Shalett Chief Investment Officer, Wealth Management

With the S&P 500 up 20% this year, outperforming markets in other parts of the world, investors are again asking why I continue to recommend staying globally diversified. For the past 10 years, U.S. stocks have beaten non-U.S. stocks by an average of five percentage points a year. That’s a lot.

For a number of reasons, however, we may have reached a turning point in that dynamic. Indeed, European stocks have outperformed the U.S. in local currency terms over the past 12 months. But the near record-high dollar has obscured the turnaround for many U.S. investors. 

Below are five reasons why non-U.S. stocks more broadly may soon start to outperform U.S. equities: 

  • Weak economic growth may have bottomed in many parts of the world. Even as data has worsened in China, Europe and Korea, the rate of deterioration has slowed, and stock prices have generally been stable, suggesting room for improvement. In contrast, the U.S. faces weaker economic fundamentals.

  • Key policy moves could be positive catalysts. Prospects for a China trade deal and more Fed easing are catalysts that could benefit non-U.S. stocks, especially emerging markets, as I wrote recently. Meantime, political uncertainty is increasing in the U.S.

  • The weakening dollar may reverse currency-related headwinds for U.S. investors who own foreign stocks. Recently, the dollar has been weakening against a basket of foreign currencies, a trend that I expect to continue, which could be a tailwind for non-U.S. stocks.

  • Large-investor ownership of non-U.S. stocks is very low. Like individual investors, hedge funds and other institutional investors have also avoided foreign stocks. When that trend reverses, demand for non-U.S. equities could lead to additional gains.

  • Non-U.S. stocks are inexpensive. Many overseas markets appear to have fully priced in a global recession. The average price-to-book ratio of European equities is at a 40-year low. Price-earnings ratios are low historically in Europe, emerging markets, Japan and the UK. Low prices in non-U.S. stocks could lead to a strong rebound, if the global economy improves next year. 

It’s important for investors to watch the news flow to make sure policy trends don’t reverse. But the way things look now, adding an actively-managed global stock fund to your portfolio could make sense.

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

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