The Morn’ of the Foreign?

Nature’s first green is gold, Her hardest hue to hold…So dawn goes down to day. Nothing gold can stay.. – Robert Frost – Nothing Gold Can Stay

Investors may have been thrilled to realize that all that was necessary to restore the pre-2022 luster to the stock market was the simple matter of dropping the two at the end of the year and replacing it with a three. The Wall Street Journal enthused “Nasdaq Posts Best January Since 2001”. The S&P 500’s +6.28% return for the month was certainly a pleasure to experience but even better was the performance of small cap stocks (S&P 600) +9.49% and mid cap stocks (S&P 400) 9.23% returns. One quarter of the S&P 500’s return for the month actually occurred on the final day of the month with the market celebrating, from its perspective, the “good” news that working folks pay checks are starting to grow more slowly and the houses we live in are no longer increasing in value or at least not much. The market is clearly hoping that if the American people are able to demonstrate that the pain that the Federal Reserve has inflicted upon us is sufficiently great then maybe they won’t have to inflict much more of it upon us. We shall see.

The stock market took the month to remind those of us born in years when men named Eisenhower, Kennedy and Johnson were president that this is most definitely not the stock market we grew up with. Three of the eleven sectors of the S&P 500 were up 9% or more for the month. Leading the way was Consumer Discretionary returning 14.99%. One quarter of that sector is actually Amazon. Add Tesla into the mix and we’re at 38% of the total value of that sector in those two companies. Tesla, by the way, is worth ten times General Motors. Next up, Communication Services, returned 14.23%. Just under a quarter of that sector is Alphabet (aka Google) and with Meta (aka Facebook) we’re at 40%. In third place, Information Technology, returned 9.26% with Apple and Microsoft together representing 43% of that sector. It’s starting to look like déjà vu all over again. Big cap tech is back!

As pleasant as it’s been this month for investors in the good old red, white and blue, it’s the markets existing beyond our borders where returns for the month are so large it takes two numbers to represent them. Indices composed of the 50 largest Asian companies returned 12.48%, the 50 largest European companies 12.53% and the 40 largest Latin American companies 10.65%. Italian and German stocks were up over 12% and French and Spanish over 11%. Since September 1st of 2022 MSCI EAFE, an index of foreign developed markets, has returned 18.24%, dwarfing the S&P 500’s 3.46%. That is very interesting and well worth the taking of some of our time together to discuss both why and how long this may continue.

Once upon a time US investors could actually add to their overall portfolio returns by investing in foreign markets but that is getting to be quite a long time ago. The ten year average annual rate of return of the S&P 500 is 12.58%. Foreign developed markets have returned 4.96% and foreign emerging markets 1.49%. Returns in foreign markets, not to place too elegant a phrase upon it, rhyme with duck. Investors would have to had the life span of Bowed Whales and Giant Tortoises, together with perfect foresight, to view investing in foreign markets as having been a particularly good idea. Peering back through the mists of time we may recall a time when, prior to its becoming history’s longest lasting deflating asset bubble, the Japanese stock market was the world’s largest, thereby assisting foreign developed markets in their outperforming the US five fold from 1971 to 1988. From 1988 to 2002 the US matched Japan’s stock market’s deflation with our own inflation as the US outperformed foreign developed markets ten fold. For the five years, from 2003 to 2007, the US underperformed by half but since then, as previously noted, its been all USA all the time.

The extended and fairly dramatic variance in the performance of the two markets has left foreign markets valued at roughly 80% of the size of their economies in contrast to the US whose stock market is valued at just over twice that of our own. Not to get (hopefully) too “geeky” here but the contrasts in the valuation of the two market universes really are striking. Citing the US first and foreign developed markets second; Price/Earnings 16.92 vs 12.10; Price/Book Value (the liquidation value of a company) 3.20 vs 1.52 and dividend yield 1.88 vs 3.92. Before we wander off this path lets first define foreign developed markets which is one-third Japan and the United Kingdom. Adding in France and Switzerland gets us to half and tossing in Germany, Australia and the Netherlands to three-quarters. Emerging markets are two-fifths China and Taiwan. Add in India and South Korea and we’re at two-thirds. Add Brazil, Mexico and South Africa and we’re at 80%. So, just possibly, the variance in the valuation of the two markets has reached such extreme levels that this year may see a narrowing of that differential, not by the US’s failure to create favorable returns but by foreign markets creating returns more favorable still.

60/40 investors saw their portfolios experience returns of approximately 4 ½% for the month with the equity share contributing 6 ½% and the fixed income 1 ¼%. Investors’ portfolios, in the absence of significant deposits or withdraws, achieved their maximum values at year end 2021. The average investor experienced losses of 15% in 2022 so we’re now closing in on the need for an additional 10% to match their end of 2021 values and achieve new all time highs. The tail winds are growing stronger and the headwinds are likely to continue to abate so here’s hoping 2023 will be a year to celebrate!

Mark H. Tekamp; February 2, 2023