In a recent blog post, I looked at long-term (10-year) performance patterns of value and growth equities and argued that, despite poor recent results, value is likely to outperform over the next decade.
In a similar vein, I’ve been having discussions with asset owners about the performance differential between US and non-US equities. As with value and growth, the data shows a clear trend of US outperformance. For example, US equities have outperformed EAFE equities on a one-, three-, five-, 10-, and 30-year basis. Over the last decade, the US has outpaced EAFE by 8.1% per year — a substantial margin.1
In the value/growth analysis, historical data showed that outperformance tended to flip-flop from decade to decade. In particular, one decade of growth outperformance was never followed by a second. That’s not true with US/non-US equities, but some similar ideas still hold. Figure 1 compares the trailing 10-year relative performance of US and EAFE equities (on the x-axis) with the forward 10-year relative performance (on the y-axis) using data back to December 1969. A few notable points:
- Historically, after US equities outperformed on a trailing basis by an annualized 7.7% or more (orange rectangle), EAFE equities always outperformed on a forward basis. If this pattern holds, the current trailing difference (8.1%) suggests that EAFE equities could outperform over the next 10 years.
- After EAFE equities outperformed on a trailing basis by an annualized 7.4% or more (green rectangle), the US always outperformed on a forward basis.
- There have been periods when either EAFE equities outperformed for two decades in a row (gray rectangle) or US equities did (blue rectangle).
- Since 1989, EAFE equities have never outperformed by more than 6% annualized in a decade, although from 1979 – 1989 there were stretches when it outperformed by as much as 9.5%.
The correlation of the trailing and forward 10-year difference in returns is -0.6, using either monthly or quarterly data.1 The explanatory power (R-squared) suggests that this single factor (trailing 10-year difference in returns) could explain more than one-third of the forward variability of US versus EAFE equities. As discussed in my value/growth note, we should be careful about putting too much weight on long-term (decade) data studied at a shorter-term (monthly/quarterly) frequency because of legitimate overlapping data concerns, but — as with value/growth — I think these results are still illustrative of the cyclical US/non-US relationship.
Beyond the data, one compelling argument for prospective non-US outperformance comes from the fact that most of the “story” supporting long-term US outperformance (more innovative companies, greater weight to technology companies, lower taxes, less regulation, faster growth) has been true not just in the last decade but over most of the last 50 years. But for much of those 50 years (and, in particular, for the first 40), non-US companies outperformed their US peers, despite these supposed headwinds. For more on this research, see the latest issue of my Top of Mind publication. There I also discuss our team’s 10-year capital market assumptions, which favor non-US equities by a healthy margin.
While the historical evidence for decade-by-decade reversals in US versus non-US performance is not quite as compelling as for value versus growth, I have almost equal confidence that non-US equities are likely to outperform over the next decade.
1Sources: MSCI, Datastream, Wellington Management. Based on total returns as of 31 December 2020. Investments cannot be made directly into an index. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS AND AN INVESTMENT CAN LOSE VALUE.