2019 closed out another year of US equity (S&P 500) outperformance vs. its non-US counterpart, (MSCI ACWI ex US). In fact, the S&P 500 has outperformed the MSCI ACWI ex US index in eight of the last ten calendar years. This persistence may lead investors to question the relevance of maintaining a globally diversified equity portfolio. Notwithstanding this recent US outperformance, there are multiple factors to consider, including similar extended periods of non-US equity outperformance in the past, differences in sector compositions within the indexes, the impact of the US dollar, and narrow leadership within the US markets.
Recent Performance Overshadows Past Cycles
Relative asset class performance moves in cycles and currently, within global equities, the US is enjoying a superior run. Over the past ten calendar years through 2019, the S&P 500 index outperformed the MSCI ACWI ex US index by just over 800 bps (annualized) and outperformed in eight of the last ten calendar years. Looking back to the ten calendar years ending 2010, the MSCI ACWI ex US outperformed the S&P 500 index by more than 450 bps (annualized), and similarly outperformed in seven of those prior ten years. A review of rolling calendar ten-year periods highlights the cyclicality of returns. The S&P 500 outperformed the MSCI ACWI ex US over the preceding six rolling calendar ten-year periods, however the MSCI ACWI ex US outperformed the S&P 500 for eight consecutive rolling ten-year calendar periods prior.
Differences Between the US and Non-US Equity Indexes
There are notable differences with respect to the composition of the two indexes, adding to the discussion around the divergence in performance. Most recently, the Information Technology (IT) sector weight within the S&P 500 was 27.5%, more than twice that of the MSCI ACWI ex US at just 11.0%. The IT sector has been one of the best performing sectors in global equity over the last ten years, and many of the prominent IT companies are US domiciled. On the flip-side, the MSCI ACWI ex US index carries heavier weights to the more traditionally value-oriented sectors, such as Financials and Materials, and acknowledging these sector weighting differences as well as a low interest rate environment in the US that served, in part, as a catalyst to higher valuations for asset-light, long-duration equities (specifically growth-oriented technology stocks), this diversion in performance is easier to understand.
US Dollar Trends are a Factor
When investing outside the US, currency movements can further impact performance as US-based investors translate the performance of their non-US investments back to US dollars. When the US dollar is weak, the impact is positive, and when the US dollar is strong, the impact is negative. Over the ten years ending December 31, 2019, the impact of the US Dollar, which was generally in a strengthening trend, negatively impacted non-US equity returns by approximately 2% annually. For the ten years ending December 31, 2010, when non-US equities outperformed US equities, the US Dollar was weakening, providing an added benefit. Timing a reversal in the trend of the US dollar, or any currency is difficult. However, should a reversal occur, this will likely serve as an added tailwind to US investors holding non-US assets.
Narrow Leadership in the US – Diversification Outside the US
Within the S&P 500, leadership has been narrow in terms of names and sectors. By the end of 2019, Alphabet (Google), Amazon, Apple, Facebook, and Microsoft contributed 27% of the S&P 500’s cumulative three-year return. While not all are classified as IT companies, they arguably have elements of IT within their business models and benefitted from the aforementioned constructive environment (low interest rates). For US equity dominance to continue, either the growth rates must continue, or the valuation multiples mustn’t contract. The MSCI All Country World Index consists of nearly 3,000 stocks in 49 developed and emerging market countries, offering global diversification. Focusing on absolute returns by country highlights the differentiated return opportunities within this index. Over the past ten calendar years ending 2019, the top performing country has been from the emerging markets region nine times, and the one time a developed country topped the list, it was not the US. The US made the top ten five times with its best showing fourth in 2011.
Maintaining a long-term focus, while following a strategic and diversified asset allocation program can help manage portfolio volatility and improve risk-adjusted returns. While the recent outperformance of US equities vs. their non-US peers has been clear-cut, abandoning a globally diversified approach could be shortsighted as history shows that relative performance cycles over time. This also is the case with foreign currency effects, which have been a recent headwind as well. The recent outperformance of the S&P 500 has been driven by a small number of stocks which seemingly would need to continue to drive the US markets higher. However, by including non-US equities, investors may increase and diversify their opportunity set.
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Please be aware that there are inherent limitations to all financial models, including Monte Carlo Simulations. Monte Carlo Simulations are a tool used to analyze a range of possible outcomes and assist in making educated asset allocation decisions. Monte Carlo Simulations cannot predict the future or eliminate investment risk. The output of the Monte Carlo Simulation is based on ACG’s capital market assumptions that are derived from proprietary models based upon well-recognized financial principles and reasonable estimates about relevant future market conditions. Capital market assumptions based on other models or different estimates may yield different results. ACG expressly disclaims any responsibility for (i) the accuracy of the simulated probability distributions or the assumptions used in deriving the probability distributions, (ii) any errors or omissions in computing or disseminating the probability distributions and (iii) and any reliance on or uses to which the probability distributions are put. The projections or other information generated by ACG regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Judgments and approximations are a necessary and integral part of constructing projected returns. Any estimate of what could have been an investment strategy’s performance is likely to differ from what the strategy would actually have yielded had it been in existence during the relevant period. The source and use of data and the arithmetic operations used for calculating projected returns may be incorrect, inappropriate, flawed or otherwise deficient.
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