U.S. vs. international equities: Time for a portfolio tune-up?

January 07, 2022 | Kelly Bogdanova


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Investors shouldn’t fall prey to a “U.S. bias” as we think international stocks have favorable characteristics arguing for their inclusion in portfolios.

race cars driving on track

The U.S. equity market outperformed international markets once again in 2021, and this time by a wide margin.

The S&P 500 sprinted higher by 26.9 percent for the year, not including dividends, while broad European and international indexes rose by 14.1 percent and 10.1 percent in dollar terms, respectively, and emerging markets and Asia outright declined.

The U.S. equity market outperformed significantly
Price performance of major global indexes in 2021

The line chart shows the paths of five major global indexes throughout 2021. While the indexes were performing roughly equally by March of 2021, they ended the year with the U.S. market outperforming significantly. In U.S. dollar terms, the full year results were: S&P 500 up 26.9%; MSCI Europe up 14.1%; MSCI World excluding U.S. up 10.1%; MSCI Emerging Markets down 4.6%; MSCI Asia excluding Japan down 6.4%.

Source - RBC Wealth Management, Bloomberg; all data priced in U.S. dollars and through 12/31/21

Last year, the S&P 500 benefited from its higher representation of growth stocks, including technology-oriented stocks in various sectors, compared to many indexes outside of the U.S.

When growth stocks began to outperform value in the spring of 2021, and then continued to rack up more gains, the U.S. market charged ahead of international markets.

Allocations askew?

The outperformance of U.S. large-capitalization stocks is actually nothing new. The S&P 500 has put together a multiyear winning streak that began in 2011, when measured by five-year rolling returns, a standard methodology for evaluating long-term market and individual stock trends.

Such a multiyear move can throw portfolio allocations out-of-whack if left unattended. It naturally has the effect of boosting the allocation to U.S. equities at the expense of international. This can lead to a “U.S. bias” in portfolios—not just for American investors (here, we refer to this as a portfolio having a “home bias”), but also for investors in other regions who have allocations to U.S. equities.

As S&P 500 gains have piled on year after year and were further stoked in 2021, U.S. allocations may have become larger than intended.

Benefits of an international mindset

Historical data signal that U.S. equity market dominance won’t last forever.

Since 1975, U.S. versus international performance trends have moved in bunches. Both groups jockeyed back and forth with the U.S. outperforming for a number of years, and then international stocks took the mantle and led the way. During this time, the U.S. recorded three dominant periods of outperformance and international stocks also enjoyed three instances of ascendance, all of which had varying magnitudes and durations.

U.S. and international markets tend to move in multiyear cycles
Relative performance of U.S. S&P 500 versus international developed markets based on five-year rolling returns*

Area chart showing the U.S. and international developed stock markets have moved in multi-year cycles since 1975. The U.S. S&P 500 Index outperformed international developed markets from 1982-1985, 1991-2003, and 2011-2021. In all other periods, international markets outperformed the U.S. S&P 500.

*Relative performance represents the S&P 500 Index’s returns minus international developed markets’ returns (MSCI World ex-U.S.).

Source - RBC Wealth Management, Bloomberg; monthly data from 1/31/75 – 12/31/21

While there is no bell that will ring when the performance shifts from U.S. back to international stocks again—and it’s a fruitless exercise to attempt to precisely time the move—we think international stocks have favorable characteristics that argue for their inclusion in portfolios at least at a level near the long-term strategic recommended allocation:

  • Importantly, the valuation disparity between the two groups is much wider than usual. The large-cap S&P 500’s price-to-earnings ratio is high and expensive. It trades at 21.4x the 2022 consensus earnings estimate compared to a 10-year average of 17.9x and an average of 17.5x since 1990. Various developed and emerging international markets appear more attractively valued, either trading near or below their 10-year averages.
The U.S. market’s valuation is above average whereas other markets are near or below average
Forward price-to-earnings ratios based on 2022 consensus forecasts vs. the 10-year average

The chart shows the current forward price-to-earnings ratios compared to the 10-year average for five major markets, respectively. S&P 500 current 21.4x and 10-year average 17.9x; MSCI World excluding U.S. 15.5x and 15.2x; MSCI Europe 15.5x and 15.1x; MSCI Asia excluding Japan 14.0x and 13.4x; MSCI Emerging Markets 12.0x and 12.6x.

Note: MSCI World ex-U.S. represents developed markets excluding the U.S.

Source - RBC Wealth Management, Bloomberg; data as of 1/5/22

  • International indexes tend to provide more exposure to value stocks, which currently have more inexpensive valuations than usual compared to growth segments of the global equity market.
  • RBC Capital Markets sees evidence that U.S. stocks are “over-owned” compared to those in other regions—meaning, many portfolio managers around the world are holding a higher share of U.S. stocks than they normally do.
  • U.S. profit margins seem more stretched and more vulnerable to declining than margins of international indexes, in our view.
  • Developed markets outside of the U.S. have higher dividend yields: 2.59 percent for the MSCI World ex-U.S. compared to 1.29 percent for the S&P 500.

While we anticipate positive returns for the S&P 500 in 2022, and we would continue to moderately Overweight U.S. equities to start the year, at this stage, we do not recommend significantly overweighting U.S. exposure at the expense of international equities.

Now is a good time to review portfolio allocations and adjust them if needed. This can help ensure that there isn’t too much of a bias toward U.S. equities and that for diversification purposes international stocks are represented at a level at least near the long-term strategic recommended allocation in global portfolios.


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Research resources

In Quebec, financial planning services are provided by RBC Wealth Management Financial Services Inc. which is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RBC Dominion Securities Inc.