Investors are buying foreign stocks, but doing so won't push U.S. stocks down


CNBC ran a piece titled “the great rotation: why investors are suddenly buying European stocks and dumping American stocks”. This idea is nothing new. Great investors and fund managers have been urging American investors to buying foreign stocks – European and emerging markets – since January 2017. Their reasoning is sound and simple:

  1. U.S. stocks will go up because the U.S. economy is growing and some of Trump’s pro-growth policies will be approved by Congress.
  2. However, U.S. stocks will go up less than European and emerging market equities, which are relatively undervalued compared to U.S. equities
  3. We are now in the final few years of the current economic expansion. The world economy will go up together, so all stock markets around the world will rise in unison.
  4. It is now safe to buy European and Chinese stocks. This was not the case before 2017. The European economy was sinking slowly from 2013-2015. China’s economy was deteriorating from 2012-2016. Now that both of these economies have made a soft landing, it is safe to buy their stocks. And since these equity markets are relatively undervalued compared to the U.S., they will probably go up more than the S&P 500.

Exactly how relatively undervalued are foreign equity markets? We can compare via several methods:

  1. How much is the market above its 2015 high?
  2. How much is the market above its 2009 low?
  3. What is the P/E ratio for that country’s main stock index?

Let’s take a look at several countries.

China

China’s Shanghai Composite:

  1. 37% BELOW its 2015 high.
  2. 93% above its 2009 low.
  3. A P/E ratio of 18.8

As you can see, China isn’t that cheap from a P/E ratio perspective. This is because although Chinese stocks have fallen a lot from their 2015 highs, their earnings have fallen significantly too.

Russia

Russia’s MICEX index:

  1. 8% above its 2015 highs.
  2. 90% above its 2009 low.
  3. A P/E ratio of 9.2

Russia’s P/E ratio is significantly lower than that of China’s and most European stock markets.

Germany

Germany’s DAX:

  1. DAX is right below its 2015 highs!
  2. 241% above its 2009 low.
  3. For a developed nation, DAX has a relatively low P/E ratio of 13.5 (12 months forward earnings)

Canada

Canada’s S&P/TSX:

  1. Like Germany, S&P/TSX is right at its 2015 highs.
  2. 108% above its 2009 low
  3. S&P/TSX has a very high P/E ratio. It’s trailing P/E is 27 (very similar to the U.S.’).

UK

The UK’s FTSE 100:

  1. Merely 2% above its 2015 high.
  2. 110% above its 2009 low.
  3. The UK has a very high P/E ratio of approximately 34.

For comparison, the U.S. S&P 500:

  1. 10% above its 2015 high
  2. 254% above its 2009 low
  3. A P/E ratio of 26

Conclusion

As you can see, the U.S. is relatively expensive compared to certain developed countries such as Germany and certain developing countries such as Russia (from a P/E perspective). However, the S&P is not wildly more overvalued.
Does this mean that you should buy foreign stocks? Probably not. We aren’t. There are several problems.

  1. It’s not guaranteed that “cheaper” stocks will outperform “more expensive” stocks. Some renown investors argue that undervalued stocks perform better, while others argue that growth stocks that are already expensive will perform better. Since there is no definitive answer to this conundrum, there is no point in buying undervalued stocks just because you think they’ll go up more.
  2. If Trump passes some of his pro-growth policies, perhaps the U.S. stock market will rally more than foreign markets?
  3. If our long term bullish outlook is wrong, all equity markets around the world will be annihilated. Right now, all stock markets are moving together. This means that investors who are buying European equities will not dump U.S. stocks heavily. Either we all die together, or we all rally for another 2-3 years.
  4. Stick with what you know. We understand U.S. stocks the best, so we do not deviate from our expertise. Our model and U.S. economic indicators state that the U.S. stock market will go up in the next few years.

The Sydney Opera House at 6 a.m.

8 comments add yours

  1. I’m with you. I hear everybody touting Europe but I don’t quite understand everything that is going on with the EU. So I do wonder how the European stock markets will be affected with the Brexit and potential other countries jumping out. Should be an interesting time.

    • There is one point I agree with European investors though. The French election will be the last major hurdle for European stocks. Once that happens (it seems likely that Le Pen will lose), it’s all clear skies for European stocks. That’s the last major political hurdle

  2. I typically stick to US stocks however I do have a small percentage going to International funds in my work 401k. A small attempt to diversify I guess.

    • I admire people who do invest in foreign stocks. From my experience, it’s a hit or miss kind of thing. That’s probably because I don’t know enough about foreign markets.

  3. I think you are definitely right. I just stick with index funds b/c practically all major American corporations have lots of foreign exposure so I already have lots of international trades in place.

    • Very true. Studies show that although 70% of U.S. GDP has no correlation with the economies of other countries, something like 50% of earnings are from ex-U.S.

  4. Excellent observations and statistics, Troy. Like Jason I am mostly invested in US companies since most of them now do get a lot of their profits from overseas. But, I did recently open a Schwab Global Investing account to specifically participate in foreign exchange markets. I’ve only used it so far to invest in Canadian mining companies on the Toronto Stock Exchange.
    Though, picking individual European stocks is more difficult for me since I don’t know that many (other than the big ones). Might make more sense to divert some money to a Vanguard (or other cheap) international fund.
    Scott

    • I think stocks in Canada and Australia will do well over the next few years. Most of these are commodity producers, so as commodity prices rise their profits and sales will rise. In addition, a declining USD is bullish for these stocks too.

Leave a Comment