Recent data and negative market performance of US equities, resurge the question of whether an investor should hold in its portfolio only American companies either individually picked or via indexes. Institutional investors are executing a rotation out of US stocks towards developed and emerging markets. But what is it that they are seeking? Generally, the investor is looking for positive returns, hence the quest for opportunities in good companies and/or undervalued markets.
The Case for ex-US Equities
The shift suggests a broader reassessment of the protracted "US exceptionalism" narrative over the past half-century.
Beyond that, there's a valuation matter. In Europe, the price-to-earnings (P/E) divergence vs. overseas, is as attractive as it has been since the 1980s.
Around the globe, “cheaper” markets, P/E-speaking, are easily found. The map below well represents this trend. In descending order: U.S. 25; India 23; France and Canada and Belgium 19; UK and Germany 18; Netherlands 15 and Italy 13. What's more curious is that China and South Korea have an average market P/E of 10. In other words, it's a 60% discount from the current US market valuation.
Source: Worldperatio.com
Since directly investing in indexes is impossible, we must rely on investment vehicles of which the most famous and generally convenient for investors are ETFs. Below will be used some approximation for the indexes (e.g. for Europe and China are available different indexes, presented are just one per macro area, as a proxy).
So, moving away from theory, into practice, let's look at the investable horizon:
- The STOXX 600 (one of the proxies for the European market) tracked by several ETFs like EXSA, has a P/E of 17;
- The Indian Nifty 50, traced by the INDY ETF, has a P/E of 21;
- The Hang Seng (Chinese market), investable through iShare's ETF called “3115 HK”, has a P/E of 14.
As the reader has sensed, very attractive alternative (financial) markets are available at the moment.
Adding to the appeal of ex-US markets is the changing global economic landscape. Ray Dalio (Trades, Portfolio) (Trades, Portfolio) - one of the most prominent hedge fund managers and global macro investors - has detailed the concept of a "changing world order”. In particular, he highlights the cyclical nature of global power, suggesting that the US may be headed for slower economic growth, and the US dollar (also called the greenback) could face challenges to its reserve currency status.
The fundamental cause of these factors is the overheated US economy, coupled with decelerating job growth and the looming risk of the US dollar losing its reserve currency status. All potentially leading to the US losing its dominant position in the geopolitical landscape and the financial markets. Or in the opposite order, considering the crucial role of finance in the current and future economy.
Will all this be true, why not start divesting from US markets?
Fact-Checking
Because not all companies listed on US financial markets are US-only, but rather multinational, the composition of these companies reveals a significant international presence. Specifically, S&P Global data indicates that in 2017, 44% of S&P 500 revenues originated from international markets. While this figure has fluctuated, the most recent reading is that 41% of revenues of S&P 500 companies are earned from outside the US, as shown in the chart below (right side column).
Source: Author's work. Data from OCIS and Bloomberg via Citigroup as of July 25, 2024. Russell 2000 is a proxy for the vast majority of US-listed companies, while S&P500 of just the top 500 in terms of capitalization.
Thus, buying US-listed companies does not automatically equate to a 100% domestic revenue exposure.
One point still stands: valuation. Lower multiples are indeed attributed to ex-US markets. A reason for this may be thatthe geopolitical situation is more complex for foreign investors to analyze in countries like China and South Korea. The situation in India, which has long been a UK colony, is perhaps more in line with the rest of the commonwealth also in terms of accounting rules.
During the whole discussion, the reader may have spotted a missing country. Japan.
The reference index for that market is the TOPIX and as tracked by 1475.T, it sports a P/E of 14.
Warren Buffett (Trades, Portfolio) (Trades, Portfolio) Endorsement of Japan
“Berkshire Hathaway Boosts Stake in Japanese Trading Firms” was a recent news title.
Indeed the Oracle of Omaha, via his holding company Berkshire Hathaway Inc. has increased its stakes in Japan's five leading conglomerates, signaling strong confidence in their long-term prospects. The real reason behind it may be revealed shortly when he is scheduled to speak at the annual shareholder meeting on the first Saturday of May. Perhaps the recent shift from deflation to mild inflation and corporate governance reforms are signs of a potential resurgence in the region. His preference for the top five holding companies is detailed in several articles online; therefore, we will not dig deeper into this writing. Berkshire Hathaway's holdings are now at around 9% in Mitsui & Co. (8031), Mitsubishi Corp. (8058), Sumitomo Corp. (8053), and Marubeni (8002), while at 8% in Itochu Corp. (8001).
This endorsement highlights the growing appeal of markets outside the US and the belief that other markets may be poised for growth.
This is a recurring theme in Mr. Buffett's investment strategy, as demonstrated by the chart below. The average revenue billed from outside the US ('ex-US revenue') for the top holdings of his stock-picking portfolio has remained stable at approximately 50% over the last three fiscal years. Unfortunately geography breakdown data for Japanese firms were not readily disclosed in their annual filings, but an assumption can be made that a good chuck of their revenues are generated in the US as well, perhaps around 30%.
Source: Author's work based on publicly availble data from annual filings.
How Does the US Stand vs. Other Global Indices?
When comparing US equities to other global indexes it's essential to recognize that the US holds a significant weight in many global benchmarks, such as the MSCI ACWI (All Country World Index). The weighting of US equities in globalindices, such as the MSCI World index sitting around 66.8 percent means that a big portion of global diversification still contains high US equity exposure (Japan comes second at 4.7%, then UK with 3.4% and China with 3.0%).
Therefore, even diversified global investment strategies still maintain a substantial reliance on the performance of the American Stock market.
Will the US Retain its Position?
Despite the challenges, the US retains several advantages. Its capital markets remain the most liquid and sophisticated in the world, attracting global capital and fostering innovation. While other financial hubs, such as the UK, face challenges in attracting IPOs, the US continues to be a preferred destination for listings: “Primary listings on the UK bourse have dropped over 40 percent since 2007” - as per the Financial Times.
Furthermore, factors like political stability, freedom of speech, and relatively low corporate taxation contribute to the US'sattractiveness. However, the future remains uncertain, and the US must navigate evolving geopolitical and economic forces to maintain its position. Extending trading hours in North America may be an adding, yet minor, catalyst going forward.
