Will the recent outperformance of U.S. stocks continue?

Jean-Pierre Couture, Portfolio Manager, Hexavest, and Robert Brunelle, Senior Vice President, Hexavest

Montreal  - A number of our clients have recently asked our opinion on the long-term benefits of investing in European and Asian shares. These are typically benchmarked to the MSCI EAFE Index, which captures the performance of developed-market equities in in Europe, Australasia and the Far East, excluding the U.S. and Canada.

Given the challenging political landscape in Europe post-Brexit vote and the muddle-through economy in Japan, should investors focus on U.S. shares that could benefit from a stronger, more stable economy?

The recent performance of the U.S. stock market relative to developed international equities, especially expressed in U.S. dollar terms, might also influence asset allocators. The MSCI EAFE has a five-year annualized return of 5%, compared with 14.8% for the S&P 500 Index, according to Morningstar. However, looking back at longer term performance going back to 1972, historical performance shows that there is no clear consistent winner in this battle.

Is this recent outperformance of the U.S. stock market a new trend that will persist in coming years? Here is a summary of our analysis through the lens of our three pillars:

• Macroeconomic environment:  The U.S. holds the edge, but the outlook for international developed markets is improving.
• Valuation:  The MSCI EAFE is at a 16-year low relative to the U.S. in terms of cyclically adjusted price-to-earnings (P/E) ratio.
• Sentiment:  We take a contrarian stance on sentiment. From that perspective, the significant outperformance of the U.S. market vs. the rest of the world in recent years would certainly lead to a negative assessment for U.S. shares.

The dramatic outperformance of U.S. shares combined with the relatively more stable economic outlook understandably has investors questioning the benefit of investing in other developed markets. While it's important to understand and respect the past, we are investing for the future. When we look forward, through the lens of our macroeconomic environment, valuation and sentiment pillars, we see at least as favorable an outlook for the MSCI EAFE.

Bottom line:  Couple our outlook with the proven diversification benefits, and we believe that international developed-market equities should continue to have a prominent place in investors' portfolios.