In February, we made the case that the persistent relative underperformance of developed international stocks may soon reverse. Although our call is much longer term, developed international stocks (as measured by MSCI EAFE) have outpaced the S&P 500 by 4.2% year-to-date as of May 10, 2023.
Rather than rehash the points we made in February which focused on valuation and index composition, this week we will focus on some basic behavioral principles of diversification.
First, some key facts:
- Since 2010 the S&P 500 has outperformed MSCI EAFE by a cumulative 284%. In no uncertain terms, it has been an awful stretch for international stocks.
- That said, going back to 1970 (the earliest we have international stock data), the average annual returns for U.S. stocks are 10.5% versus 9.1% for international stocks. The U.S. still leads, but the performance gap is far smaller.
- Excluding the most recent run of significant outperformance from U.S. stocks, the average annual return differential falls to nearly zero when looking at 1970 through 2012: U.S. stocks +9.7% versus international stocks +9.6%.
- Over the past 53 years, international stocks had higher returns 25 times – nearly a coin flip.
Recency bias, driven by the dramatic underperformance over the past decade, makes it feel like international stocks are perpetual losers, which is not exactly the case. As said by Ben Carlson in his publication “The Case for International Diversification:”
“It’s certainly possible your portfolio would be fine over the long-haul investing exclusively in U.S. stocks from current levels. But it’s also highly probable U.S. stocks will underperform international stocks, possibly for an extended period of time. If you could predict the future there would be no reason to diversify but no one has the ability to know what comes next in the markets or global economy. Global diversification is about accepting good enough returns to avoid the potential for terrible returns at an inopportune time.”1
1 Carlson, Ben. A Wealth of Common Sense, “The Case of International Diversification.” May 9, 2023.
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