Risk Managed Strategy Funds


LPL: Are International Stocks Too Cheap To Ignore?

July 26, 2019

International stocks are on sale, but don’t pull out your wallet just yet.

As shown in the LPL Chart of the Day, International Stocks Carry Lower Valuations, both international developed and emerging market (EM) equities carry lower valuations than the S&P 500 Index, based on forward price-to-earnings ratios (PE). Global stocks’ discounts to U.S. stock valuations are larger on average than they have been historically.


“International developed-market equities are cheap for a reason,” said LPL Chief Investment Strategist John Lynch. “In aggregate, those companies have carried lower returns on equity and offer less exposure to what have been the fastest areas of the global equity markets that investors have favored during this bull market.”

U.S. stocks boast higher profitability per share that warrants a higher price tag. S&P 500 companies, in the trailing 12 months through Jun 30th, 2019, have generated a return on equity of 17% currently, compared with 10.7% for the MSCI EAFE Index (a stock market index representing most of Europe, Japan and the Far East) developed market constituents, and 12% for companies in the MSCI EM Index. Return on equity is a measure of the profits a company generates relative to its outstanding equity. Simply put, U.S. equity investors essentially have had a claim to more profits for the shares they own.

A different sector mix accounts for some of the disparity in profitability. The technology sector, which represents more than 21% of the S&P 500 and just 6.7% of the MSCI EAFE Index, is a dramatic difference. Technology companies have typically generated higher profit margins and returns on equity than most other sectors, giving the United States an advantage.

The MSCI EAFE Index also has much more exposure to the traditional value sectors (financials, energy, materials) and the slower-growth consumer staples sector that have underperformed in recent years. These factors have contributed to faster earnings growth for the S&P 500 than the EAFE in 8 of the past 10 years. And based on FactSet consensus estimates, the United States is expected to make it 9 of 11 years this year—and 10 of 12 in 2021.

While a 20% discount for international developed-market equities might look enticing, keep in mind that most of that discount is attributable to low valuations in Japan. The MSCI Japan Index is trading more than 40% below its 25-year average forward PE, compared to Europe, which is trading 10% above its average.

From a tactical perspective, over the next 6 to 12 months, we continue to favor U.S. equities among developed global markets for the relatively better economic, profitability, and growth profiles. Our concerns about economic growth, global policies, and interest rates translate into our preference for EM stocks over international developed-market stocks. Fiscal deficits, populism, and exhausted monetary policies could weigh on sentiment, spending, and investment throughout Europe, while structural reforms and the looming VAT increase may pressure sentiment in Japan.


Source: https://lplresearch.com/2019/07/18/are-international-stocks-too-cheap-to-ignore/