U.S. stocks have enjoyed a remarkable run over the past 15 years, especially compared to equity markets in other parts of the world. But non-U.S. equities may come to play a more important role in investors’ portfolios over the next couple of years.
To put the outperformance of U.S. equities in context, consider that in 2009, the S&P 500 Index was trading below 700 following a decade-long bear market that saw U.S. stocks lag global equities. Today, the S&P 500 has soared to 5,000—more than seven times its 2009 level. When compared to world equity markets excluding the U.S.,1 the S&P 500’s compound annual return of nearly 15% has outperformed by almost 7 percentage points.
Why this big gap? After the 2007-08 financial crisis, as other regions struggled, the U.S. quickly rebounded due to extraordinary government stimulus. Companies and consumers repaired their balance sheets, and a surge in nonbank financing, particularly venture capital and private equity, fueled a tech innovation boom. Then came the pandemic and the 2023 regional bank crisis, which spurred still more stimulus.
Through it all, U.S. equities continued to gain. Today, they make up a staggering 63% of the MSCI ACWI benchmark’s market capitalization, even as the U.S.’s share of global GDP is just 24%. Such outsized impact of U.S. stocks may leave global investors feeling there is no other game in town—but Morgan Stanley’s Global Investment Committee thinks there is.
Consider International Stocks
Given today’s rich U.S. equity valuations, non-U.S. stocks may offer an attractive way to hedge your portfolio against a potential U.S. market pullback. Such a downturn is possible as U.S. policymakers weigh an end to their extraordinary support of the economy amid stabilizing growth, inflation and employment trends.
Today, gaps between U.S. and non-U.S. stocks are extreme in two areas:
- Valuations: On average, S&P 500 stocks sport a forward price-earnings ratio of more than 20, versus about 13 for the MSCI All Country World Index (ACWI) ex USA. That makes non-U.S. equities look cheap relative to their pricey U.S. peers.
- Dividends: Stocks in the non-U.S. index, on average, offer a 3% dividend yield (i.e., the dividend expressed as a percentage of the share price)—more than double that of the U.S. index’s stocks.
In particular, investors should consider opportunities in:
- Japan: The country has finally broken out of its 34-year bear market, with a benchmark equity index up an impressive 17% year-to-date. Its nominal economic growth, inflation and wages are returning to healthier levels amid government reforms that are driving improvements in corporate margins and shareholder equity returns.
- Europe: The European Central Bank is expected to begin easing monetary policy to stem recessionary conditions in the region. Plus, with 18 of 31 NATO countries now committing their agreed-upon 2% of GDP to defense spending in light of the Russia-Ukraine conflict, defense budgets are up more than 60% from a decade ago, at $380 billion. This spending, together with advances in artificial intelligence and progress toward decarbonization, is likely to fuel strong capital investment in related projects by governments and private companies.
- Select Emerging Markets: Although economic difficulties in China pose challenges for investors, the efforts of major economies to reorganize global supply chains—along with constructive fiscal policies and stabilizing politics in certain emerging-market countries—are likely to support economic growth. Look to Brazil, India, Mexico and Vietnam for opportunities.
Portfolio Moves to Consider
To be sure, we strongly believe there is a bright future for the U.S. economy, driven by a boom in productivity. However, it’s still important to consider the extreme valuation gaps between U.S. and non-U.S. stocks, as well as rising growth potential in other regions. Concerns around U.S. political dysfunction and the swelling national debt should be on investors’ radar also. If these issues cause foreign investors to rebalance their portfolios even modestly back toward their home markets, U.S. market volatility could ensue.
Consider moderating any extreme overexposure to U.S. equities in your portfolio and adding some exposure to Japan, Europe and emerging markets including Brazil, India, Mexico and Vietnam.
This article is based on Lisa Shalett’s Global Investment Committee Weekly report from February 26, 2024, “US ‘Policy Exceptionalism.’” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.
