Have you ever done an inventory of the products that you use every day? I recently did this exercise and was shocked by the domicile of the parent companies. I start my day using a product that benefits a stock being traded in Japan and finish my day with a product that benefits a company in the UK.
Inventory of everyday products
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After my inventory exercise, I wondered, Why is it ok to contribute to the top line of foreign companies by purchasing their products, but not benefit from the growth of the company because I don’t own their stocks? How much of my portfolio is made of up of these non-U.S. companies that I support financially? The answer? Probably not enough.
Foreign stocks aren’t as foreign as you think
The word foreignthrows many investors off. Non-U.S. developed market companies may be perceived to be unrecognizable names operating under different guidelines.
Samsung®, for example, is the fourth largest stock in the MSCI Emerging Markets Index by market cap as of August 2019. With over 20% global market share, Samsung has been the largest TV manufacturer since 2006.1 While there are many U.S. investors who appreciate Samsung as a leader in television electronics, they may not make the connection it’s an emerging market stock domiciled in South Korea.
Unilever, a British-Dutch company, has 27 recognizable brands in the U.S. I personally use many of them daily including: Dove® soap, Q-tips®, Noxzema® and Suave® shampoo.2 Some other recognizable Unilever brands include: Ben & Jerry’s, Klondike®, Hellmann’s mayonnaise, Lipton®, and Vaseline®.
Countries of origin and U.S. revenue stream
The reality is that markets are now global. Many of the stocks in non-U.S. developed markets are likely generating a significant amount of their revenue outside of their country of domicile. In fact, that revenue may well be coming from the U.S. For example,
- Swiss giant, Nestlé, derives 45% of its sales from the U.S.3 According to the MSCI EAFE Index, Nestlé is the largest company in the index by market cap. The company also happens to be the largest food company in the world as measured by revenues since 2014.4 Nestlé has 55% market share of the water market in the U.S.5 It’s not widely known that Nestlé owns Poland Spring®—and while the water comes from Maine, the revenue goes to Switzerland.
- Unilever generated 77% of its 2018 revenue from outside of the UK and Netherlands, of which 15% came from the U.S.6
As previously written, while investors may have reservations about allocating a portion of their investment portfolio to non-U.S. companies—they’re comfortable allocating a part of their daily consumption to the products those same companies make.
So why is it that we’ll buy food or beverage products when they are on sale at the supermarket, but when their stocks are on sale, we ignore them?
Home country bias
When I speak to individual investors about non-U.S. developed and emerging market stocks, I usually witness a scowl on their faces before I hear their thoughts on the topic. In fact, there is a term to describe an investor’s preference for stocks based in their own country:It’s called home country bias.
The chart below shows there is a tendency for investors, on average, to be overweight allocations to their home country relative to the country’s market capitalization.
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Source: World GDP (2016, in current USD)—World Bank https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?end=2016&start=1960&view=map Accessed on March 23, 2018. Market capitalization of domestic listed companies (2016, in current USD)---World Bank https://data.worldbank.org/indicator/CM.MKT.LCAP.CD?view=map Accessed on March 24, 2018. Home country equity allocation—John R. Nofsinger, The Psychology of Investing, Fifth Edition, Pearson, 2014, p. 89.
Our preference for U.S. equities has served us well over the last decade.After all, as of August 31, 2019, U.S. equities (Russell 3000 Index) have out-performed international developed stocks (MSCI EAFE Index) and emerging markets (MSCI Emerging Markets Index) for the past quarter to-date, 1-year, 3-year and 10-year periods.
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Source: FTSE/Russell, Bloomberg Barclays, MSCI and FTSE NAREIT. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Past performance, however, is no indication of future results and asset class leadership eventually changes.
Market leadership rotates
Over the last two decades, U.S. and non-U.S. developed markets have traded places.As shown in the chart below from 2001-2007, non-U.S. developed market equities, as indicated by the MSCI World ex-US index, led the U.S. 11.6% vs. 5.2% for 17 quarters.
In 2007, U.S. markets took over and continue to lead through the second quarter of 2019.
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Morningstar Direct. FRED (Federal Reserve Economic Data). Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. See disclosures for ratio definitions.
The S&P 500 has led for 29 quarters, generating an 8.4% annualized return, vs. the MSCI World ex-U.S., which led for 19 quarters and only generated a 2.1% annualized return.
Cycles cannot be predicted and no cycle is the same, however, it can be said that U.S. markets are probably in the latter part of the cycle.
Valuations matter
We believe the price you pay for an asset is important.In order to have proper perspective on valuations, you can look at forward price-to-earnings (P/E) ratios and projected earnings growth.
If we were to compare emerging markets, Japan, Europe and the U.S., many investors in the U.S. might be surprised to see that emerging markets are trading at the lowest forward P/E (12.1x) with the highest projected earnings growth (10.9%) as shown in the chart below.
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Data as of June 2019. Source: MSCI Country and regional Indexes, Bloomberg Barclays country and regional indexes. Russell Investments calculations. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. See disclosures for ratio definitions.
Stocks in Europe are trading at a forward P/E of (13.5x) with projected earnings growth of 5.8%.Compared to the U.S., emerging markets and Europe are trading at attractive levels on a forward looking basis.
Bottom line
U.S. investors are not immune to having home country bias.We have proof that the average U.S. investor has just shy of 90% of their assets in U.S. stocks.The U.S. equity markets are now in the eleventh year of a bull market, as measured by the S&P 500, and valuations are at the highest on a relative basis compared to the rest of the world.7
We believe now is an opportune time to help investors evaluate what they own and determine if their portfolios are positioned for what is to come as opposed to what has already happened.
If we only had access to one global stock exchange, we believe investor behavior would be much different.Investors would likely focus more on valuations and earnings growth and less on headline news and the country of origin.
The stocks of some of the largest brands and products internationally are currently on sale with stronger earnings growth than their U.S. counterparts. It is impossible to time when a market cycle is going to change, but we do know that asset prices matter.We believe now is the time to seriously consider diversifying portfolios by increasing allocation to non-U.S. stocks.
Remember, foreign stocks aren’t as foreign as you think.
1 Global HD TV Market Report 2018-2022
2 https://www.unilever.com/brands/?Country=408018&page=2
3 https://www.nestle.com/investors/annual-report
4,5 Statistica: https://www.statista.com/statistics/268894/food-sales-of-the-nestle-group-by-region/
6 Statistica: https://www.statista.com/statistics/269195/revenue-of-the-unilever-group-by-region/
7 Source: https://www.wsj.com/articles/what-yogi-berra-would-have-said-about-this-bull-market-11560524404
Disclosures
Trailing price-to-earnings (P/E) is a relative valuation multiple that is based on the last 12 months of actual earnings. It is calculated by taking the current stock price and dividing it by the trailing earnings per share (EPS) for the past 12 months.
Forward price to earnings (forward P/E) is a quantification of the ratio of price-to-earnings (P/E) using forecasted earnings for the P/E calculation.
Cyclically adjusted price-to-earnings ratio, commonly known as CAPE, Shiller P/E, or P/E 10 ratio, is a valuation measure usually applied to the US S&P 500 equity market. It is defined as price divided by the average of ten years of earnings (moving average), adjusted for inflation. As such, it is principally used to assess likely future returns from equities over timescales of 10 to 20 years, with higher than average CAPE values implying lower than average long-term annual average returns.
Price-to-cash-flow ratio is a stock valuation indicator that measures the value of a stock’s price to its cash flow per share. The ratio takes into consideration a stock’s operating cash flow (OCF), which adds non-cash earnings such as depreciation and amortization to net income. It is especially useful for valuing stocks that have positive cash flow but are not profitable because of large non-cash charges.
Price-to-book ratio compare a firm's market to book value by dividing price per share by book value per share.
Price-to-sales ratio is a valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the value placed on each dollar of a company’s sales or revenues. It can be calculated either by dividing the company’s market capitalization by its total sales over a 12-month period, or on a per-share basis by dividing the stock price by sales per share for a 12-month period.
Performance quoted represents past performance and does not guarantee future results.
Indices and benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Index return information is provided by vendors and although deemed reliable, is not guaranteed by Russell Investments or its affiliates. Due to timing of information, indices may be adjusted after the publication of this report.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI.
Bloomberg Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. (specifically: Barclays Government/Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).
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MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.
MSCI Emerging Markets Index: A float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
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Russell 1000® Index: Index measures the performance of the largest 1000 U.S. companies representing approximately 90% of the investable U.S. equity market.
Russell 3000® Index: Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market
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