Are International Equities Poised to Take Center Stage?
A look inside the data reveals that a change may be on the horizon and a globally diversified equity allocation may be rewarded in the coming years.
The 10 years ended December 31, 2019, saw the U.S. take center stage when it comes to equity outperformance over its international counterparts, driven largely by investors’ expectations that the U.S. economy would grow faster (and it did). Will the next 10 years be more of the same or are there signals that a change in leadership will occur? A look inside the data reveals that a change may be on the horizon and a globally diversified equity allocation may be rewarded in the coming years.
Using a sum-of-parts framework to look at the drivers of that outperformance—valuation expansion, earnings growth, and U.S. dollar appreciation—Vanguard research found that the continued long-term outperformance of U.S. equities is unlikely.
Drivers:
Change in valuations
Valuations can either contract (downward change) or expand (upward change).Earnings growth
Earnings per share is a key metric of corporate profitability, and if valuations are constant, higher earnings growth rates will increase equity prices.Dividend yield
Dividend yield represents the cash return to investors.Foreign-exchange return
The foreign-exchange return applies to the foreign currency exposure that investors obtain by owning non-U.S. dollar-denominated assets.
Will the next 10 years tell a different story?
This same framework can also be used to explain our forward-looking expectations. Our belief is that investors will have lower return expectations for U.S. equities relative to international equities going forward based on an inverse relationship between starting valuations and an expected valuation contraction in the U.S. over the next 10 years.
Don't forget to look at starting valuations
When looking at valuations, where you start has a lot to do with where you end. When analyzing this key metric, generally the higher the starting valuation, the lower the expected 10-year return. As you can see in the charts below, U.S equities clearly have much higher starting valuations than their international counterparts.
