Good day, everyone. Well, what a difference a year can make. Who would have imagined from the lows of last spring that we would have seen the global stock market recover to the extent that it has? But that snapback certainly was anything but uniform. This uneven recovery, in our view, allows active investors to rotate into other areas of the market that may not have participated to the same extent that others had.
One area in particular that we are finding favorable at this point is international equities. Some of the reasons why is, first, they offer different sources alpha. In plain English, that means that you can’t find some of the opportunities here in the United States. You have to look further abroad.
Second, by diversifying into international stocks, that could mitigate some of the concentration risk we’ve seen emerge over the last few years in some of the key US stock market indices, in particularly the large-cap indexes. And the icing on the cake: we’ve seen valuations in the international equities at levels we haven’t witnessed in quite some time.
But first, let’s take a step back and look at one structural element, and that is at the index level. This has had an influence on the returns of not only international stocks, but US stocks as well. When one looks at the index content of international versus US equity indices, there’s a higher cyclical component in the international indexes versus those of their US counterparts. This, coupled with the fact that we had more moderate economic growth coming out of the global financial crisis, served as a headwind for this asset class.
However, we’re starting to see the global economy turn around, which could in turn lead to a nice reversal of fortune for this asset class.
On the other side of the coin, when we look at US stock markets, they did quite well. But they were led by, in many cases, a handful of select stocks. For example, if you look at the S&P 500 at the end of 2020, the top five names in that index represented 22% of the index itself, while the top five names in the MSCI EAFE index, by comparison, were roughly a third of that.
So looking outside of US borders is one way to mitigate this concentration risk, if you will, especially if the stock markets continue to broaden out as they have over the last few months.
Casting a wider net has also had its return advantages. Would you believe over the last 10 calendar years that over 75% of the top 50 best-performing stocks were actually outside the US? And that’s just an average. In some years, it was 90%. And last year it came in at 96%.
So how do you find these opportunities?
We think it comes from sound active management, backed by in-depth research. That enables an investor to identify companies led by capable managements, companies that possess solid financial attributes that help them weather unexpected storms and those who have sustainable competitive advantages.
Lastly, let’s turn to valuations. The reality is, is international stocks are trading at a material discount versus other more crowded areas of the market. At the end of 2020, for example, US stocks as represented by the S&P 500 were trading at a material premium compared to other parts of the globe, with Europe and parts of Asia in particular being standouts.
It’s always a good idea for an investor to examine how their portfolio is positioned from a risk perspective as they seek new opportunities. One area that we feel that is fertile ground is international equities. The landscape for this asset class is looking better than it has in many years.
Thank you. And wishing you a prosperous 2021.
Walt Czaicki is Senior Investment Strategist for Equities at AB.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.