In this episode of “Investment Management Foundations,” Aya Yoshioka, Portfolio Consulting Director at Wealth Enhancement, discusses US equity market performance relative to the European Union.
VIDEO TRANSCRIPT:
Hello again, and welcome back to another segment of Investment Management Foundations. My name is Aya Yoshioka and I am a Portfolio Consulting Director and Senior Investment Strategist here at Wealth Enhancement. As we close out 2024, U.S. equity markets have had an extraordinary run over the last two years with back-to-back 20% plus returns for the S&P 500 index.
From a global equity market perspective, U.S. equities continue to be the preferred region over the Eurozone or emerging markets. So we ask, will this continue?
To answer this, let me start with the graphic that sizes up public equity markets in the U.S. versus the EU and shows public equities that have been homegrown, whether in the US or in the EU, and companies that have market caps of over $10 billion and have been around for less than 50 years. And despite a tech bubble that burst back in 2000, you can recognize many of these companies here, such as Apple, Amazon, Microsoft, and Google in these green bubbles, which represent high-tech or technology-related companies.
However, I would turn your attention to some of the blue bubbles that are here on the US side. And these blue bubbles represent similar companies of similar size, over $10 billion in market cap, been around for less than 50 years. So new companies in the US. And their bubbles are pretty big here as well, especially relative to the EU, where there's fewer bubbles and fewer green bubbles.
So, this brings us to the next page and the chart on the right that shows that since the financial crisis, the S&P 500 has outperformed the MSCI All Country World Index, excluding the US, by nearly 3X. The primary reason for this has been the earnings growth of the companies within the S&P 500, which have outpaced many other areas of the market as seen on the graph to the left. Here you can see that the S&P 500 has even outpaced US small-cap companies in terms of their long-term earnings growth, And this is a really tough feat to pull off simply because the dollar amount required in order to grow US large cap earnings by 14% versus small cap companies earnings by 14% is a much larger amount. So growth has been better for the S&P 500.
So what's the knock? Well, the forward PE ratio, the price to earnings ratio, which is Wall Street's measure of how expensive or cheap a stock might be, shows that the S&P 500 is trading well above the rest of the pack. And herein lies the conundrum. Do you lean into the US exceptionalism, expecting that the momentum in US large cap stocks will continue, despite the high valuations, or do you diversify your risk and lean into other areas of the market that are much cheaper?
When you look at where the MSCI All Country World Index, excluding the U.S., is trading, it is nearly 10 points cheaper and growing earnings at 12% versus the S&P 500, which is growing earnings at 14%. From our perspective, we believe this looks good from a risk reward perspective. And we're not saying that we should abandon all U.S. equities or that international and emerging market equities will outperform from here. But we do acknowledge that this diversification will provide an insurance policy for when areas outside the US outperform the S&P 500.
Thank you so much for listening again today and please tune in again for another episode of Investment Management Foundations.
This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances. Investing involves risk, including possible loss of principal.
There is no guarantee that asset allocation or diversification will enhance overall returns, outperform a non-diversified portfolio, nor ensure a profit or protect against a loss. Investing involves risk, including possible loss of principal.
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