The S&P 500 Index has posted a 365% gain since the bear market bottom in March 2009, and that has many investors and market historians expecting sharply lower returns ahead. Meanwhile, a study by Research Affiliates indicates that investors should tilt from U.S. to international equities for the next decade, according to a report in Barron's.
Research Affiliates is the investment advisory firm founded by Rob Arnott, known for developing smart beta investing strategies. During the next decade, they forecast an average annual inflation-adjusted real return of 5.3% for the MSCI EAFE Index, which captures developed market equities in Europe, Australasia, and the Far East, and a 7.3% average real return for emerging markets stocks. By contrast, they expect annual real returns of just 0.5% for the large cap S&P 500 and 1.9% for the small cap Russell 2000 Index.
- The next decade is likely to see meager returns on U.S. stocks.
- Many foreign markets are much cheaper, and have significant upside.
- However, foreign stocks have their own sets of risks.
Significance For Investors
The Russell 2000 has yet to regain its late August 2018 record high, and currently trades about 9% lower. Prior to the Russell's year-end selloff in 2018, Research Affiliates expected it to perform about as poorly as the S&P 500 going forward.
With interest rates now near historic lows, Research Affiliates expects that the Bloomberg Barclays U.S. Aggregate Bond Index will return a negative 0.3% per year, while U.S. Treasury Inflation-Protected Securities (TIPS) will return a mere 0.4% annually.
Real estate will be a disappointing investment as well, with REITs delivering an annualized real return of just 1%. Most REIT indexes are up by about 25% in 2019, posting gains similar to the S&P 500.
Lisa Shalett, chief investment officer (CIO) for Morgan Stanley Wealth Management, also suggests that investors look abroad for better equity returns, per another Barron's report. She notes that the MSCI Europe Total Return Index, priced in euros, has outperformed the S&P 500 Total Return Index during the past 12 months. Moreover, in the U.S., stock valuations are high and earnings growth has diminished.
By contrast, Shalett observes that valuations abroad are much lower, to the point where they are "washed out." Anticipating that global economic growth may rebound, partly due to easing by central banks, she writes, “The pay-off from this type of positioning [i.e., rotating from U.S. to international stocks] could be large as non-US markets are inherently more cyclical in their composition and thus more operationally leveraged to improvements in global growth."
Other investment professionals have similar observations. “Stocks are significantly cheaper in other parts of the world,” as Bill Stone, co-chief investment officer at wealth management firm Avalon Advisors in Houston, told The Wall Street Journal.
“Based on current valuation levels, which help play a role in determining equity returns over the next several years, foreign markets appear more attractive than U.S. markets,” notes Michael Sheldon, chief investment officer at RDM Financial Group-HighTower Advisors in Connecticut, per the same Journal report.
Foreign stocks come with their own sets of risks and caveats. There are serious political and economic troubles even in the developed world. For example, the European Union (EU) is contending with a new populist government in Italy and Brexit is still a much-delayed work in process that continues to spawn uncertainties across the continent.