Coming into 2022, many investors felt global markets were poised to deliver strong relative returns compared to the US market. At the risk of oversimplifying the narrative in support of non-US equities, we think this line of argument rested on three primary pillars: 1) US stocks had easily outdistanced most developed and emerging markets for years, and we were due for a change in leadership (e.g. reversion to the mean); 2) US equities traded at historically high multiples compared to developed and emerging markets, and that gap was poised to close (e.g. valuation support) and 3) many ex-US indices were heavy with companies in financial services and commodities - the types of enterprises that would benefit as global growth accelerated and interest rates moved higher (e.g. a post-Covid economic reopening and high inflation were relative tailwinds for ex-US markets). And while markets struggled broadly for the first two months of the year, non-US markets did outperform the US market.
Then, Russia invaded Ukraine and our existing geopolitical construct was turned on its head, as was the return stream from US and non–US stocks. Said differently, since February 23rd, the S&P 500 Index is up about 7% while the EAFE Index is up about 1% (see chart – we don’t want to paint with too broad a brush; some non-US markets continue to lead the US, but there has been a noticeable shift in performance and investor sentiment toward US / non-US markets since the invasion).
Ultimately, markets look past geopolitical crises and come back to what drives returns – earnings, interest rates, and economic fundamentals. As Europe tries to reset its political and economic relationship with Russia, recession risk has risen in that part of the world (there is not only the challenge of managing the humanitarian crisis that Russia’s invasion has unleashed but the fact that 40% of the natural gas consumed by the EU comes from Russia). Meanwhile, the US economy – outside of the impact of higher commodity prices – remains much more insulated from the events in Eastern Europe and remains on firm footing as we move into the spring (consider that initial US jobless claims fell to a 52-year low last week). We think the US is the best house in an increasingly unsettled global neighborhood, and that US equities merit an overweight relative to non-US equities.