Markets

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

It has been a year of milestones for U.S. stocks. The S&P 500 closed above 2,500 for the first time on Friday. The Dow Jones Industrial Average topped 20,000 in January. And let’s not forget the countless highs this year.   

As my Bloomberg Prophets colleague Ben Carlson pointed out last week, the market is on track for another feat. The S&P 500 has suffered at least one negative month every year since 1927, the first full year for which numbers are available. But the index is up every month this year, including dividends, and it’s up again in September through Tuesday.  

Positive Thinking
The S&P 500 could post a year without any negative monthly returns
Source: Bloomberg

Don’t pop the champagne corks just yet, however, because devotees of U.S. stocks are poorer for their affection this year. Yes, the S&P 500 has returned 13.6 percent this year through Tuesday. But overseas markets have done even better. The MSCI World ex USA Index -- a collection of stocks in developed countries -- is up 19.6 percent, and the MSCI Emerging Markets Index is up 31.3 percent. 

Something to Celebrate
Despite all the attention heaped on U.S. stocks this year, there's been more to cheer overseas
Source: Bloomberg
Note: Indexed to 100.

So why all the fuss about U.S. stocks when they’re lagging the rest of the world? The answer is home bias. U.S. investors are more comfortable with companies in their own backyard than in far-off locales, so that’s where they park their money. As a result, they also keep a close eye on U.S. market gauges such as the Dow and the S&P 500. The financial media makes it easy by featuring those gauges prominently on TV, online and in print, which further reinforces investors’ bias that the world revolves around U.S. stocks. And around it goes. 

That home bias has been costlier this year than investors most likely realize. U.S. investors typically allocate 70 percent of their stocks to the U.S. and 30 percent to developed international markets. By contrast, the global equity market capitalization is closer to 50 percent U.S. stocks, 40 percent developed international and 10 percent emerging. The difference translates into an additional 2.4 percentage points for the global market cap allocation this year through Tuesday.  

Investors’ home bias may cost them even more in the years ahead. U.S. stocks can’t continue beating their peers in other developed countries indefinitely. The growth of stock prices, after all, depends on earnings growth, which in turn relies on GDP growth.  

And GDP growth in the U.S. bears a striking resemblance to growth in the rest of the developed world. According to IMF data, the average annual real GDP growth for the 22 countries in the World ex USA Index was 2.6 percent from 1980 to 2016, the longest period for which numbers are available. During the same time, real GDP in the U.S. grew by 2.6 percent annually, too.

In fact, U.S. and developed international stocks grew at roughly the same rate for nearly four decades. The World ex USA Index returned 11.6 percent annually from its inception in January 1970 to August 2007, while the S&P 500 returned 11.2 percent. But more recently, U.S. stocks have raced ahead. The S&P 500 has beaten the World ex USA Index by 5.5 percentage points annually over the last 10 years through August.

Old Normal
U.S. stocks have alternately led and lagged stocks in other developed countries
Sources: S&P, MSCI

Which isn’t unusual. There have been numerous 10-year periods during the last five decades in which U.S. stocks have beaten developed international stocks. Then as now, there was no reason to expect a lasting divergence between the two, and the trend eventually reversed.

The same analysis applies to emerging markets, except that emerging-market stocks should outpace those in the U.S. over time because emerging economies enjoy higher growth rates. The average annual real GDP growth for the countries in the Emerging Markets Index was 3.9 percent from 1980 to 2016 -- more than 50 percent higher than the U.S. growth rate.   

Stock prices in emerging markets have historically reflected that higher growth. The Emerging Markets Index outpaced the S&P 500 by 3.8 percentage points annually from its inception in January 1988 to August 2007. But they, too, have stumbled in recent years. The S&P 500 has beaten the Emerging Markets Index by 4.9 percentage points annually over the last 10 years through August.

Second Fiddle
Despite their recent success, U.S. stocks still lag those in emerging markets
Sources: S&P, MSCI
Note: Indexed to 100.

Which, here again, isn’t surprising. There have been many 10-year periods in which U.S. stocks have beaten those in emerging markets. But fueled by their fast-growing economies, emerging markets have always caught up.  

I don’t mean to be a buzzkill. By all means, investors should celebrate every record for U.S. stocks and all the money they made in recent years on the home team. But they should also bear in mind that other teams are now doing even better.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nir Kaissar in New York at nkaissar1@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net