My first professional employer was a firm in Baltimore by the name of Mercantile Bankshares (MSD&T). In the early to mid-1990s, it was what you might call the “white shoes” bank and trust department in town, managing multiple billions of dollars in client assets. That was back when the S&P 500 was in the 400s. General Electric and IBM were dominant U.S. corporations, and a billion dollars still meant something.
My department was responsible for the management of the MS&T Funds, a proprietary mutual fund family. Personally, I was fortunate enough to manage one of the “floating NAV” funds, the MSD&T Maryland Tax-Exempt Bond Fund, and managed or co-managed several of the “stable value” 2a-7 (money market) funds. However, being the proverbial low man on the totem pole, I was also unfortunate enough to have to write and rewrite the prospectuses and annual reports when necessary.
If you click on the link and read the verbiage for the municipal bond fund, you might recognize my writing style, or a very early version of it.
In any event, during my tenure there, we added the “International Equity Fund” to the lineup. Since we didn’t have any real expertise in foreign equities, we hired a firm out of Edinburgh, Scotland, to be the sub-advisor. We is a strong word choice there, because I didn’t have any part in the decision-making process to hire Dunedin Fund Managers, Ltd., the name of the firm.
Regardless, the International Equity Fund was incredibly popular with our trust administrators and advisors. If memory serves, that is all anyone really wanted to discuss for a while. After all, and believe it or not, international investing wasn’t anywhere near as mainstream for the retail investor as it is now. I mean nowhere near it, and having the fund made us a little unique compared to our local competition.
Then, when the investment returns didn’t match the sizzle, fund inflows largely stagnated. It wasn’t Dunedin’s fault. The U.S. was simply a better bet in the mid-1990s, specifically 1995 and 1996, which is when I left the company.
I tell you that little story because I have been struggling with international investments for a long period of time – almost three decades. They are sort of like the congealed salad my mother used to serve every Thanksgiving. It wasn’t any good, but, by God, we had to eat it. To that end, since the end of 1989 through the end of October 2024, the S&P 500 has had a total rate of return of 3,181.27%. By comparison, the international equivalent, MSCI EAFA, has returned 427.96%.
That works out to be 10.53% and 4.89% when annualized. Truthfully, you would have done better investing in the Lehman/Bloomberg US Aggregate Bond index over that time, 454.42% and 5.04% respectively. Seriously. So, equity-like volatility and bond-like returns?
I’ll pass for now. However, will international equities ever outperform American ones moving forward?
Frankly, it depends on your time horizon. Are you talking three-months, three-years or a decade? If the former, the yes – international stocks will occasionally outperform domestic ones over a three-month time period. They might even do so over a three-year window, although my conviction is not as strong about that. Finally, I would much rather own U.S. stocks over any 10-year cycle in the future. Period.
The reason is pretty simple. International investing essentially asks two questions:
- What are the prospects for the local reporting currency relative to the U.S. dollar?
- What are the prospects for the local economy relative to the U.S.?
For example, let’s assume I am exploring a fund which invests only in companies headquartered in the United Kingdom. So, what are the chances the British pound is going to significantly appreciate relative to the U.S. dollar? Also, what is the likelihood the UK economy is going to grow more rapidly than the American one? Intuitively, the two will usually go hand in hand.
Let’s think about that for a second. What comparative advantage does the British economy have over the American? Britain Ltd. versus corporate America? How about France, Germany, Italy, Canada and Japan against the United States?
The size, transparency, liquidity and economies of scale of their financial systems and investment markets? The innovation of their private sector? Their entrepreneurialism?
To be sure, comparing the U.S. equity markets to international ones is almost like comparing the tech sector to utilities. Will tech stocks always beat utilities? Over every trailing time period and until the end of time? Of course not. However, over the next decade, would you prefer to own tech stocks or utilities? I mean, if you had to bet all of your money on one sector, which would it be? Tech or utilities?
I imagine most people reading this newsletter would probably opt for tech stocks. It isn’t that utilities don’t play a role in portfolio diversification. They do. However, which would you rather have? All other things being equal?
To be sure, an obvious counter to my argument for U.S. stocks would be “the developed international markets are so much cheaper than the U.S..” By most traditional valuation measures, this is a completely accurate statement. The U.S., as defined by the S&P 500, has higher price/earnings (P/E), price/book (P/B) and price/sales (P/S) ratios than the MSCI EAFE Index. Frankly, they aren’t even close.
So, at some point, international stocks will surely outperform domestics, right? That would be a very real possibility if traditional valuation tools were the only reasons why stocks perform the way they do. Shoot, it would be a probability and not a possibility. However, they aren’t. Investors want to put their money where the growth is likely to be.
Consider this. According to my trusty Bloomberg terminal, the P/E, P/B and P/S ratios for Alphabet Inc. Class-A shares are ALL significantly higher than that of, say, Ford Motor Company, significantly. Yet, guess which one has a 12-month price target of roughly +25% from today’s price and which one has a +4% one. As I type on 11/25/2024 at 2:50 pm CST.
I will give you a hint. It isn’t Ford, this despite being so much “cheaper” than Alphabet. Hey, I am not trying to knock Ford here. The truth is I am beyond ambivalent about the company. There isn’t any animus here. In the same vein, I don’t harbor any sort of ill will to the international equity markets.
If the Eurozone showed signs of long-term, systemic vibrancy, we would invest more heavily there. The same could be said of Japan or the United Kingdom. Investors don’t really care what language you speak, food you eat or clothes you wear. Seriously, they don’t. They care about generating the highest possible level of return they can for the amount of risk they are willing to take.
Given market history, breadth, liquidity, economic innovation, entrepreneurialism, prospects for continued growth and overall societal tolerance for risk, the crystal ball and tea leaves still point to the United States as the best long-term country in which to invest. If that ever changes, we will change our asset allocations to go along with it.
So, why this topic and why today? Well, it is Thanksgiving week and I am extremely thankful in doing this job for a living in the United States. It offers the best potential for a long-term return, and has ever since I got into the industry in the early 1990s.
Have a great weekend.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.