One of today’s most pressing investment questions is the valuation level of the U.S. equity market. To understand the nature of the question, we review the relative valuation of competing asset classes, in particular, those that are comparable in terms of overall characteristics. In the table on page 2, we contrast other classes of equities against the dominant domestic benchmark, the Standard & Poor’s 500® Index. The point of this process is to identify more favorable risk versus potential return environments. As you can see from the two charts on the left, the domestic equity market, medium and small capitalization, has been remarkably homogeneous. This is particularly true since 2009, and an anomaly from a historical perspective. It really speaks more to the devastation of the financial crisis. So, there does not appear to be a broadly neglected and, thus, undervalued segment within the domestic equity sphere. But looking at the charts on the right, a very different situation becomes clear. Relative to the U.S. market,both the emerging and, in particular, the developed international markets have, until this year, underperformed.While the year-to-date performance of both the EAFE® and EM has been strong, they have considerable ground to cover to match the returns posted by U.S. stocks during the last decade.
I have repeatedly written about the level of complacency pervading the domestic market, so much so that the opportunities elsewhere may be overlooked. At the close of the recent earnings reporting season, the forecast for revenue growth of the S&P 500® Index was lifted to 7%, while the outlook for the EAFE® constituents was raised to 8% and 11%-12% for the EM. International investing does entail additional risks, such as currency fluctuations, liquidity and, of course, political. It is critical to be mindful of these challenges and have a time horizon sufficient toweather the increased volatility. At this time, two facts can be agreed upon: valuations ex-U.S. are lower and growth expectations are higher. The goal of investing is to be adequately compensated for the risk taken, and a lost opportunity is a risk as well.