Harding Loevner: International Outperformance?

07/27/2017 2:54 am EST

Focus: GLOBAL

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

International equities are currently experiencing their longest period of underperformance relative to the U.S. stock market, explains Ian Wyatt, editor of Million Dollar Portfolio.

A report from Brandes Investment Partners says that underperformance has been underway for more than 100 months. The previous cycle of underperformance lasted 90 months, ending in December 2001.

Following that period of underperformance, international equities outperformed for the subsequent 78 months. What were the annualized returns? 11.2% for international, versus just 3.6% for U.S. stocks.

It stands to reason that international stocks will be in favor once again. And when that happens, we'll expect to see considerable outperformance.

Since the beginning of this year, international stocks have actually been outperforming. The following chart shows the performance of the MSCI EAFE (EFA) versus the S&P 500 (SPY). We think it's likely that this outperformance will continue for the next couple years.

chart

Why has the U.S. dominated, while other developed nations have lagged? There are several reasons. First, the U.S. is thought to be one of the safest markets in the world.

Even with slow growth, America's vibrant technology sector has been booming. In times of uncertainty, investors decided to park their money in American stocks. And that's helped drive prices higher for everything from blue chips to biotechs.

Second, the U.S. was the first country to aggressively cut interest rates. That helped jumpstart the economy faster than in Europe and Japan.

Third, the U.S. led the way with quantitative easing. While we can debate whether or not the expansion of the government's balance sheet was a sound policy decision, it certainly helped the economic rebound in the short term.

As a result, the U.S. economy is a couple years ahead of the recovery that's still unfolding in other developed nations around the world.

Today, U.S. stocks are priced at the high end of their historical valuation range. Meanwhile, stocks in Europe and other developed nations are more attractively priced. And the economic recovery in these other developed nations has considerably more room to grow.

The combination of extended underperformance, lower valuations and prospects for faster economic growth make investing outside of the U.S. compelling.

Given my expectation for continued outperformance of international investment, I'm adding to our current portfolio position in Harding Loevner International Equity (HLMNX).

This is a long-term equity mutual fund that's focused on international investments. The fund has 51% of assets invested in Europe, 19% in emerging markets and 13% in Japan. The balance of the fund's assets is invested primarily in Asia and the Middle East.

This year, the fund is experiencing very good performance with 17% year-to-date gains. Average annual returns over the last five years is 9.8%, a bit ahead of the benchmark index. The fund has $8.4 billion in assets under management, a $5,000 minimum investment and a 1.1% expense ratio.

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