U.S. Stocks set to Outperform International Stocks in 2014 12-5-14

Summary:

  • U.S. Stocks Set to Outperform in 2014
  • U.S. on pace to add most jobs in 15 years
  • ECB talks inflation

Since exiting the recession in mid-2009, US stocks have significantly outperformed international markets.  With less than a month left in the year, it appears this will once again be true in 2014. There are many reasons for this, but this is partly due to investors viewing the United States as a “safe haven” in the storm following the global recession.  However, prudent portfolio diversification requires allocation to international, emerging market and commodity based stocks, as well as fixed income.

It would be wonderful to have a crystal ball that would tell us which asset class would outperform the others over the next year.   A well-diversified portfolio over the past several years would not have kept pace with the S&P 500, even with a portfolio overweighting U.S. stocks.  The good news is that over the long run, International, Emerging Market and Commodities based stocks are very likely to “catch up” on a valuation basis which could lead to excellent overall portfolio returns for properly diversified investors who are patient and disciplined enough to stay the course by keeping International Stocks and the other asset classes that have underperformed over the past few years.  Also, a strong dollar has played its part in reducing the already poor returns provided by international stocks. Remember, a U.S. investor in foreign markets benefits if the U.S. dollar depreciates in the investment period.  The chart below shows how various sectors performed over the last several years.

As you see, there is not one asset class that consistently outperforms every year.  A diversified portfolio (the white box highlighted as “asset allocation”) is the most effective way to smooth out the “ride” that stocks can take us on from time to time and is therefore a very important part of portfolio management.

For the past seven years there were reasonable arguments for keeping money in the United States.  While the United States endured a brutal recession and it is still suffering through an anemic recovery, on a relative basis the economy has been a bright spot, particularly compared to Europe and Japan. Since the end of the recession corporations have churned out record profits, the dollar has been stable, and interest rates remain low.  Corporate profits in the U.S. have increased since 2008, when the percentage was only 6.9%, compared to 12.8% in 2013.

International stocks —especially European and Japanese stocks—have been reeling since the recession due to many factors, including poor growth.  The combination of these factors has led to U.S. markets outperforming since the recession. The next part of this series sheds light on the attractiveness of various markets compared to U.S. markets.

While U.S. stocks still appear reasonably priced, and downright cheap compared to fixed-income alternatives, they are relatively expensive compared with other countries. U.S. large caps trade for 2.6 times book value compared with 1.9 for the rest of the world. This represents a 37% premium. U.S. stocks look particularly pricey compared to Europe, which has a price-to-book ratio of 1.73; Japan with a price-to-book ratio of 1.53, and emerging markets with a price-to-book ratio of 1.40.

The S&P 500 is slightly richer than other developed markets and much richer than emerging markets. They’re trading at approximately 16.11x, 14.29x, and 11.13x times their earnings, respectively. The U.S. index is trading at well above its five-year average, which is 15.5x. Developed (VEA) and emerging markets are trading below their five-year average, which stands at 16.8x and 12.6x, respectively.  As you will see  on the chart below, this “spread” has widened lately, especially in emerging markets.  This can spell out opportunity, especially as we rebalance portfolios.

International and emerging market stocks present a great opportunity for investors over the next few years and we will continue to maintain them as part of a balanced, well-diversified portfolio.

U.S. adds 321,000 jobs in November:

The U.S. economy added 321,000 jobs last month, keeping the economy on track to record its strongest year of job growth in 15 years.  This represents the largest one-month increase in payrolls since January 2012.  These numbers were also well-above consensus expectations of a 230,000, exceeding even the most optimistic economist projections.  The unemployment rate held steady at 5.8%, still a six-year low.  The report today also showed positive revisions for the jobs numbers released in September and October.  Employers added 44,000 more jobs in September and October than previously estimated.  October’s payroll gain was revised up to 243,000 (from 214,000) and September’s growth was revised up to 271,000 (from 256,000). Job growth was broad-based, with factory payrolls rising the most in a year and professional and business services taking on the largest number of workers since November 2010. Employment in business and professional services climbed 86,000 last month, while payrolls rose by 28,000 at factories. Retail employment increased by 50,200 in November–the most this year. Of particular interest to Fed officials, the report showed wages accelerating with average hourly earnings climbing 0.4% (versus 0.2% expected)-the strongest monthly increase since 2011. The average work week increased to 34.6 hours, the highest since May 2008, resulting in greater take-home pay for workers. The participation rate, which indicates the share of working-age people in the labor force, held steady at 62.8%.

European officials must take bolder action in 2015:

The European Central Bank’s Governing Council expects to consider a package of broad-based asset purchases including sovereign debt, according to two ECB officials. The officials said no decision on implementing quantitative easing has been taken yet, and the composition of the program may be influenced by incoming data. At the press conference following yesterday’s policy meeting, ECB President Mario Draghi said that policy makers “won’t tolerate” a prolonged period of low inflation, and that officials discussed “all assets but gold” as potential targets for purchases, much like what the Bank of Japan is currently doing to stimulate their economy.