Are International Markets Back?


Very slowly, almost stealthily, international equity markets are clawing back relative to the United States. On a dollar-adjusted basis Japanese stock returns are now on par with the United States, with both the S&P 500 and the Nikkei 225 up around 4.5% year-to-date. And more recently, international markets are actually leading. Since late July the S&P 500 is down over 1%. During the same time period Europe has advanced 1% in dollar terms, a broad emerging market index is up more than 3% and Japan is up nearly 5%. Returns are based on Bloomberg data.

What accounts for the turnaround and, more importantly, can it continue? Three factors stand out:

1. U.S. growth remains uninspiring, despite expectations for a rebound.

The relationship between economic growth and market performance is unreliable and often non-existent. But for a market that is increasingly dependent on earnings growth, a lack of economic growth is a challenge. Although the U.S. economy continues to grow, it is not obvious that it is accelerating. More interestingly, relative to other parts of the world U.S. economic data is disappointing. The Citigroup Economic Surprise Index is once again negative for the U.S. while it is positive for a broader array of major economies.

2. The Federal Reserve will no longer ride to the rescue.

For most of the post-crisis period investors could, and often did, dismiss soft growth on the assumption it would lead to more monetary easing. That is no longer likely. While the Fed has verbally committed to a shallow and short tightening cycle, interest rates are still likely to rise. This is also putting upward pressure on the dollar, which will in turn pressure U.S. earnings.

3. U.S. stocks are expensive; other markets aren’t.

As shown in the chart below, U.S. equities are trading at over 20x trailing price-to-earnings (P/E) and over 26x cyclically adjusted earnings (Shiller P/E). Valuations at these levels have historically been associated with lower forward returns. In contrast, equity markets in Europe, Japan and emerging markets appear somewhere between fairly valued and relatively inexpensive.


For long-term investors, the final point is particularly important. Value is often irrelevant in the short term, but over the long term valuations tend to mean-revert. For example, during the past 60 years, annual changes in the P/E of the S&P 500 had a -0.20 correlation with the change the following year.

This is one of the reasons many investors are lowering their long-term return assumptions for U.S. equities. Indeed, the BlackRock Investment Institute forecasts a 4% annual return for large cap U.S. equities over the next five years. This below-average forecast assumes a steady 2% annual compression in multiples. In other words, if correct, investors will be less willing to pay more for each dollar of earnings and stocks will climb at a much slower pace.

Many international markets face their own challenges, but at the very least they are less likely to contend with the steady headwind of multiple compression. This suggests that the recent recovery in international markets can continue.

Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation team and is a regular contributor to The Blog.


Investing involves risks, including possible loss of principal. Diversification strategies do not guarantee a profit or protect against loss in declining markets. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

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The Big Trends in the Global Economy

Global Growth

A lot has seemingly happened in the global economy in recent months, from a plunge in the oil price to a surge in the value of the US dollar against foreign currencies to an election in Greece that led to renewed fears about the possibility that the euro zone would break apart. But what’s been the upshot of all these changes? The latest World Economic Outlook report from the International Monetary Fund provides some data to answer that question.

According to the IMF’s report, the global economy is expected to grow by 3.5% this year. That’s lower than the projection of 3.8% growth that the IMF made six months ago. The change is largely the result of slower expected growth from emerging markets (5.0% six months ago versus 4.3% now). The prospects for developed economies, on the other hand, have actually improved slightly. While the estimated 2015 growth for the US hasn’t changed (it’s still 3.1%), the IMF boosted its growth estimates for the euro area and Japan.

Even though expectations have declined for emerging economies as a whole, not every country has a similar story. Six months ago the IMF expected a positive growth rate this year in Russia and Brazil; now it expects both countries’ economies to get smaller. The anticipated growth rate for China has also declined, although it’s still very high at 6.8%. India has gone in the other direction. Six months ago the IMF was projecting that India’s growth this year would be 6.4%. The latest estimate is 7.5%.

It’s important to remember that there’s only a weak link between economic growth and stock market performance, so simply buying stocks of fast-growing countries (or stocks of countries where the economic outlook has improved) probably isn’t a good idea. In fact, China and Russia have been among the best-performing stock markets so far this year. Still, thinking about the global economy in terms of these numbers may make the big-picture trends more apparent.

The Importance of International Diversification

International diversification

With a seemingly constant drip of bad news from around the globe—military conflicts in Eastern Europe and the Middle East, the spread of Ebola, slowing economic growth in Western Europe and many emerging markets—it may feel that the US is the only safe place to invest your money. But not having enough exposure outside the US means not enough diversification, and that can actually mean higher risk and potentially lower returns over the long run.

The performance of international stocks is driven by some of the same factors that affect US stocks. An upturn or downturn in the global economy, for example, may have an impact on stocks from all countries. But there are plenty of other things that can affect stocks in some countries but not others, such as different valuations, different economic growth rates, different demographics, and different political environments.

These differences mean that international stocks often don’t move in lockstep with US stocks. US stocks substantially outperformed international stocks in 2013, for example, but actually underperformed in 2012 despite the economic woes of the euro zone. Having exposure to both the US and to international markets therefore can mean fewer large ups and downs for your entire portfolio.

Despite overseas wars and economic weakness abroad, the benefits of a globally diversified portfolio may become even more apparent in the coming years. As we’ve noted before, US stocks currently appear to be slightly overvalued by historical standards. This fact doesn’t necessarily mean that US stocks will do poorly, but it increases the chances that their future returns will be below average.

Valuations on international stocks, by contrast, appear to be more in line with historical norms. Strategists at Research Affiliates project that over the next 10 years, current valuations will reduce the returns on US stocks by an average of 1.5% per year. For international developed stocks they think this number will only be 0.6% per year, and for emerging market stocks they think current valuations will actually increase returns by an average of 0.4% per year. Not having enough international exposure, in other words, could mean more risk and less reward.

Different Countries, Different Sectors


US and international stocks often perform differently, which is why the result of owning both is usually a better-diversified portfolio. There are many reasons for these performance disparities, such as different economic conditions, different laws and regulations, and different effects from currency movements. Yet there’s another key difference that’s often overlooked: US and international stock markets tend to be made up of very different types of companies.

Led by companies such as Apple, Google, Microsoft, technology is the biggest sector in the S&P 500 index of large US stocks. Since there are fewer large technology companies based in foreign countries, however, technology is one of the smaller sectors among international stocks. In the other direction, the financials and materials sectors are much better represented among international stocks than among US stocks.

For individual countries, the differences with the US can get even more extreme. About half of Russia’s stock market is comprised of energy companies, compared to less than 10% in the US. And many emerging markets, including Brazil, China, and Russia, have almost no companies in the health care sector.

As a result of these differing sector breakdowns, factors that help or hurt a specific sector can disproportionately affect the performance of stock markets in some countries. When deciding how to invest internationally, understanding the implications for the sector exposures of your portfolio is an important consideration.