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Mutual funds
White paper
Global investing: Open for opportunities
The case for portfolio diversification with international equities
Mark Hackett
Chief of Investment Research,
Nationide Financial
SUMMARY
KEY HIGHLIGHTS The U.S. equity market has consistently outperformed international stock
• U.S. stocks have outperformed markets since the end of the financial crisis due to faster economic growth,
international stocks since the expanding price-to-earnings multiples and greater exposure to the technology
market bottom in 2009, but sector. Because of the structural, political and demographic challenges
current valuations appear to facing international markets, many investors are wondering if the time
favor developed and emerging for international exposure in a diversified portfolio has passed. While the
international stocks.
duration and magnitude of underperformance has been severe, exposure
• Sectors and industry exposures to international markets may continue to provide diversification benefits.
in international stock indices Moreover, the stage may be set for international stock markets to catch up to
are substantially different than U.S. stock markets.
the S&P 500, offering different
diversification and income PERFORMANCE: GOING GLOBAL CAN LOWER RISK
benefits.
The S&P 500® Index has outperformed the MSCI EAFE by an average of 7.5%
• Most international economies and the MSCI Emerging Market Index by 6.5% annually since the end of the
continue to lag the U.S. in
financial crisis. Through that period, the U.S. has experienced faster economic
vaccine distribution and
and earnings growth, but has also benefitted from substantial expansion
business re-opening, which
may lead to strong relative of stock valuations. On a rolling yearly basis, the international indexes have
performance when the U.S. mostly underperformed the S&P 500 (See Chart 1 on following page).
growth cycle peaks.
Periods of outperformance and underperformance of international
stocks versus U.S. stocks tend to be lengthy; the last extended period of
outperformance for international stocks occurred after the technology
bubble of the late 1990s and early 2000s. There are other similarities to
that period, including elevated valuations in the technology sector and
substantial outperformance of growth stocks relative to value. International
equity markets tend to be dominated by cyclical and traditional value
sectors, including financials, industrials and consumer cyclicals, while the S&P
500 is dominated by technology. Through April 2021, international stocks
substantially outperformed U.S. markets as investors shifted to pro-cyclical
and value-oriented stocks, though that trend reversed modestly in June as
growth returned to leadership. If value sectors begin to catch up to growth,
international equities are likely to follow suit.
Despite the extended period of underperformance, exposure to international
stocks in a diversified portfolio has lowered volatility relative to a portfolio
White paper nationwidefunds.com | 1solely comprised of U.S.-only stocks. As illustrated (See standard deviation of the S&P 500 over that time was
Chart 2 below), a portfolio with a 40% allocation to the 16.2%. Moreover, the balanced portfolio had a better
MSCI World Index had a 14.4% standard deviation over Sharpe ratio, reflecting the diversification benefit of
the 51 year period from 1970 to 2021. In comparison, the investing internationally.
Chart 1: Relative performance vs. S&P 500 Index (trailing 12 mos.) Chart 2: Portfolio standard deviation, 1970-2021
0.8 18.0%
MSCI EAFE Index (developed market international stocks) vs. S&P 500
MSCI Emerging Market Index vs. S&P 500
0.6
17.0%
[Description]
Source: FactSet.
0.4
Standard deviation
16.0%
0.2
15.0%
14.0%
-0.2
0%/100% 20%/80% 30%/70% 40%/60% 50%/50% 60%/40% 70%/30% 80%/20% 90%/10% 100%/0%
-0.4 May-03 May-05 May-07 May-09 May-11 May-13 May-15 May-17 May-19 May-21
Allocation to S&P 500/MSCI World ex-USA
Source: FactSet, 06/30/21. Source: Morningstar, 06/30/21.
Past performance does not guarantee future results.
RECOVERY: GLOBAL STOCKS CLOSE THE GAP
The global economy staged a remarkable recovery stages of a global recovery. But as the U.S. economic
from the lockdowns in 2020, helped in large part by recovery matures, the rest of the world often catches up,
aggressive fiscal and monetary support (See Chart performing better in the mid-to-late phases of the global
3 below), along with earlier vaccine distribution and expansion. This is particularly true for emerging markets
resumption of mobility and business activity. The rest of that are reliant on developed market consumers and
the world has also benefitted from aggressive fiscal and businesses to drive their economic growth.
monetary spending, but economic re-openings in other
Leading indicators show a balanced recovery among
countries have generally lagged the U.S. Recent data
geographies. (See Chart 4 below.) China was the earliest
from global economies suggest a strong recovery may
economy to slip into recession and showed the sharpest
be in the offing.
decline, but China has also experienced the strongest
It’s not unusual for the U.S. to lead the rest of the world recovery from recession lows. Trends in the U.S. and
out of recession, as historical patterns show the U.S. among advanced OECD economies are largely consistent
is often among the strongest economies in the early in their declines and recoveries.
Chart 3: Global central bank balance sheets ($ trillion) Chart 4: Leading economic indicators of major global economies
$30.0 105.0
European Central Bank
Federal Reserve
$25.0
Bank of Japan 100.0
Bank of England
$20.0 Swiss National Bank
[Description] [Description]
95.0 United States
Source: Source: European Union
$15.0
Japan
90.0 China
OECD countries
$10.0
85.0
$5.0
Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20 Sep-20 Dec-20 Mar-21 May-21
Source: Federal Reserve Bank of St. Louis (FRED), 06/30/21. Source: FactSet, 06/30/21.
White paper nationwidefunds.com | 2VALUATION: OPPORTUNITIES AT A RELATIVE DISCOUNT
International stock indices have substantial sector and Emerging Markets indices has been far more modest.
industry exposure differences to the S&P 500® Index. (See Chart 5 below.) Valuation is traditionally a poor
For example, the MSCI EAFE Index is comprised of more predictor of near-term returns but has strong inverse
pro-cyclical and value factors; as of June 30, 2021, the correlation with longer-term results; stocks purchased
financial, industrial and consumer discretionary sectors at modest valuations have historically produced better
comprise 46% of the MSCI EAFE Index. Conversely, returns. This occurred following the technology bubble,
the S&P 500 is more exposed to growth factors, where international markets enjoyed an extended period
with technology, consumer discretionary and health of outperformance.
care comprising 53% of the U.S. index’s weight. The
The sector exposures also lead to a substantial yield
differences in sector exposure tends to lead to extended
advantage for international equities over U.S. stocks. As
periods of outperformance and underperformance, but
of June 30, 2021, the MSCI EAFE and Emerging Market
also provides a diversification benefit to investors.
indexes yielded 2.9% and 2.5% respectively, a solid
The post-financial crisis period is notable for the strong advantage over the 1.5% dividend yields for the S&P 500.
performance of growth stocks versus value and domestic (See Chart 6 below.) In periods of strong price returns,
U.S. equities versus international. This outperformance investors pay less attention to dividends. But as the cycle
has created a stark valuation difference between U.S. matures and returns become more difficult to achieve, a
and international stocks. The price-to-book ratio for the 100-basis point advantage in yield will provide a tailwind
S&P 500 tripled from 1.4x to 4.2x since 2009, while the for relative returns.
price-to-book multiple expansion for the MSCI EAFE and
Chart 5: Price-to-book ratio (next 12 months) Chart 6: Dividend yield (next 12 months)
for major global stock indexes for major global stock indexes
S&P 500® Index
S&P 500® Index
4.00
5.0 MSCI EAFE Index
MSCI EAFE Index
MSCI Emerging Market Index
MSCI Emerging Market Index
[Description] [Description]
3.00 4.0
Source: Source:
2.00 3.0
1.00 2.0
Jun-01 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13 Jun-15 Jun-17 Jun-19 Jun-01 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13 Jun-15 Jun-17 Jun-19
Source: FactSet, 06/30/21. Source: FactSet, 06/30/21.
Past performance does not guarantee future results. Past performance does not guarantee future results.
GROWTH: EARNINGS WILL LIKELY BE KEY
Growth for developed international markets has been for advanced economies and 8.9% estimated growth for
sluggish since the global financial crisis. From 2013 emerging economies. While population growth and other
through 2019, the U.S. grew an annualized rate of 2.5%, demographic trends may continue to push domestic
slightly ahead of the 2.2% annualized rate of growth growth above that of the developed world, U.S. growth is
for advanced economies (which includes the U.S.) likely to lag the developing world.
but below the 4.3% annualized pace of growth for
Earnings growth will likely be key in determining the
developing economies and global pace of growth of 3.3%
long-term relative performance of domestic U.S. stocks
annualized. (See Chart 7 on following page.) Between
versus international markets. The recovery in earnings
2019 and 2022, the United States is forecast to grow a
in 2021 is strongest outside of the United States, with
cumulative 6.4%, compared with 4.3% estimated growth
notable strength in emerging markets. (See Chart 8
White paper nationwidefunds.com | 3below.) Beyond this year’s recovery, expected growth indexes, highlighting the substantial valuation gap and
rates are similar among the U.S. and international stocks opportunity available from international equity markets.
Chart 7: Cumulative real Gross Domestic Product
Chart 8: Earnings growth of major global stock indexes
growth (2019-2022 est.)
60%
115
Estimated
United States 48% S&P 500® Index
Advanced economies
110 39% MSCI EAFE Index
40%
Emerging economies 36%
Stacked MSCI Emerging Market Index
Worldarea chart illustrating Bond Issuance per year from 1996 to
Area chart illustrating fixed income flows (funds and ETFs) from
2020. Categories include Municipal, mortgage-related, federal agency
105
January 2013 to March 2021.
securities, treasury, corporate debt and asset-backed. 20%
Source: IMF, Morningstar. 12%
Source: IMF, Morningstar. 9% 9% 9% 8% 9% 8%
100 6%
4%
1%
-5%
95
-11%
-14% -14%
-20%
90 -22%
-40%
2019 2020 2021 2022 2023 CAGR
4Q 2019 2Q 2020 4Q 2020 2Q 2021 4Q 2021 2Q 2022 4Q 2022
Source: FactSet, 06/30/21. Source: FactSet, 06/30/21.
Past performance does not guarantee future results. Past performance does not guarantee future results.
CONCLUSION
The global recovery from the coronavirus pandemic economic expansion. Given the severe valuation
has arrived, and central banks around the world and performance gaps, international stock markets
remain committed to driving economic growth. could see an extended period of outperformance
The rest of the world is mostly behind the U.S. that has not been seen since the years following
in terms of business re-opening, vaccination the technology bubble. Additionally, given the
distribution and economic trajectory. But as other greater dividend yield and diversification benefit,
countries and regions catch up with the U.S., equity exposure to international equities is important for a
markets are likely to reflect the opportunity for well-balanced portfolio.
Key takeaways
1 2 3
At current valuation levels, Adding international stocks to The U.S. has mostly led the
international stocks appear to a portfolio of predominantly global economic recovery from
offer better potential relative domestic U.S. stocks offers the pandemic recession, but
to U.S. stocks for future return potential for greater other global regions are poised
opportunities. diversification and lower risk. to close the gaps in growth.
White paper nationwidefunds.com | 4ABOUT THE AUTHOR
Mark Hackett serves as Chief of Investment Research. As a leader for Nationwide’s capital markets analysis, Mark
develops content to educate financial advisors and their clients on financial markets and implications for investors.
In this role he is responsible for asset class research, market commentary, white papers and topical market pieces.
Mark brings more than 20 years of experience in the asset management industry, including roles in research for both
Nuveen and Vanguard Group and as a portfolio manager for Nuveen. He began his investment career at the Vanguard
Group as a research associate in the fixed income group.
Mark has been interviewed by and quoted in numerous media outlets, including The Wall Street Journal, CNBC.com,
CNN Money, The Associated Press Money and several others. He also contributes weekly market commentary to the
Nationwide Advisor Advocate Blog.
He earned his Bachelor of Science in Business Administration with concentrations in Finance and Economics at
the University of Richmond, holds Chartered Financial Analyst (CFA) and Chartered Market Technician (CMT)
designations and is a member of the CFA Institute.
This material is not a recommendation to buy or sell a financial product or to adopt an investment strategy. Investors
should discuss their specific situation with their financial professional.
Except where otherwise indicated, the views and opinions expressed are those of Nationwide as of the date noted, are subject to change at any time and may not come to pass.
S&P 500® Index: An unmanaged, market capitalization-weighted index of 500 stocks of leading large-cap U.S. companies in leading industries; gives a broad look at the U.S. equities
market and those companies’ stock price performance.
MSCI EAFE® Index: An unmanaged, free float-adjusted, market capitalization-weighted index that is designed to measure the performance of large-cap and mid-cap stocks in
developed markets as determined by MSCI; excludes the United States and Canada.
MSCI Emerging Markets® Index: An unmanaged, free float-adjusted, market capitalization-weighted index that is designed to measure the performance of large-cap and mid-cap
stocks in emerging-country markets as determined by MSCI.
Nationwide Funds are distributed by Nationwide Fund Distributors LLC (NFD), member FINRA, Columbus, Ohio.
Nationwide Investment Services Corporation (NISC), member FINRA, Columbus Ohio.
Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company. © 2021 Nationwide
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