Why macroeconomic predictions can be misleading
Andrew Suzman
Equity Portfolio Manager

The past year has reminded me that predictions based on macroeconomic events can be unreliable guides to the future.

A year ago, if I told you that the war in Ukraine would continue to drag on, that the European economy would produce virtually zero growth and that U.S.-China tensions would intensify, I doubt you would have expected a positive return for international stocks. And yet, despite the escalating war in Ukraine, skyrocketing energy prices, record high inflation and weak economic growth, European markets have staged a powerful rally, outpacing U.S. stocks over the past two quarters.

Even with the benefit of perfect hindsight, or a crystal ball, you might still have come to the wrong conclusion. Knowing all the macroeconomic facts in advance, we would have predicted negative returns. The headlines would have misled us.

European markets have far outpaced U.S. markets in recent months

The image shows a line graph of the relative annual return of the MSCI Europe Index in relation to the S&P 500 Index over the past year. Figures ranging from a low of 2% in July 2022 to 14% in February 2023 reflect the difference in total return on a year-over-year local currency basis between the two indexes. Along the line graph certain major events are called out. They include: worsening tensions between the U.S and China in May 2022 (3%); the first European Central Bank interest rate hike in 11 years in July 2022 (2%); energy prices in Europe reach record highs and Eurozone inflation exceeds 10% in September 2022 (4%); escalation of the war in Ukraine in February 2023 (14%); and the 60% drop of Credit Suisse shares on the heels of a banking scandal in March of 2023 (13%).

Sources: Capital Group, MSCI, Standard & Poor’s. Figures reflect the difference in total return on a year-over-year local currency basis between the MSCI Europe Index and the S&P 500 Index. As of March 31, 2023.

So why did it happen? Why did European stocks, as well as the broader universe of international stocks, do so much better than U.S. stocks? In my 29 years as a portfolio manager all I can say is, markets sometimes give you a hint that something important is going on. I think this activity in international markets is something we need to watch closely.

Why have stocks outside the U.S. had better returns?

There’s no question that valuations are generally still more attractive outside the U.S. That’s been true for a long time, but nobody has cared because it hasn’t made any difference in recent years. However, when it comes to individual companies, we may be getting some hints as to why international markets are perking up.

Take a company like Holcim, a Switzerland-based cement maker. While there is no good news anywhere to be found in the building materials sector, Holcim trades at a 10% free cash flow yield — a financial metric that compares the company’s free cash flow per share to its market value per share — and the company is growing not shrinking. Sometimes that’s good enough.

Then there’s Shin-Etsu Chemical, Japan’s largest chemical company. It has various business lines tied to housing, agriculture and semiconductors, among other areas. Shin-Etsu has a strong balance sheet, low debt levels and, like Holcim, the business is growing. Shin-Etsu trades at a price-to-earnings (P/E) ratio around 13, and Holcim carries a P/E of 11. (The P/E ratio compares a company’s share price to its net profits). These are very low valuations, compared to similar multinational companies. Maybe these low valuations, combined with earnings news that isn’t terrible, are carrying the day.

Many non-U.S. companies trade at a discount to their U.S. counterparts

The image shows a bar chart comparing forward price-to-earnings ratios for U.S. companies versus their international counterparts across six industries: technology, financials, consumer staples, food products, health and industrials. A lower P/E ratio means investors are paying less for every dollar of earnings generated by a company. Across all sectors, the graph shows the U.S. companies have a higher P/E ratio. The P/E ratios are as follows: Apple 24.3 vs. Samsung 21.3, JP Morgan Chase 9.8 vs. BNP Paribas 6.5, Procter & Gamble 22.8 vs. Unilever 17.5, Hershey 25.7 vs. Nestlé 20.9, Eli Lilly 35.4 vs. AstraZeneca 17.1 and Rockwell Automation 23.5 vs. ABB 20.7. Current price-to-earnings ratios for the S&P 500 Index, MSCI World ex USA Index and MSCI Emerging Markets Index are 17.9, 12.7 and 11.8, respectively. Their 15-year average P/E ratios are 15.9, 13.5 and 11.5, respectively.

Sources: IBES (Institutional Brokers’ Estimate System), MSCI, Refinitiv Datastream, Standard & Poor's. As of March 31, 2023. A lower P/E ratio means investors are paying less for every dollar of earnings generated by a company.

Is this the start of a new golden age for international investing?

One swallow does not make a spring. I am not here to say that international markets are going to do better than U.S. markets for years to come. There is still skepticism around that idea because it’s been more than a decade since we’ve seen it. U.S. markets have won for such a long time that nobody wants to suggest this may be the turning point. Bottom line: This may not be a “ring the bell” moment, but I think investing in international stocks is unlikely to be as disappointing as it has been at times over the past 10 to 12 years.

Is it time for international stocks to retake the spotlight?

The image shows the relative outperformance of the MSCI EAFE Index represented by blue peaks versus the S&P 500 Index represented by gray peaks from January 31, 1973, to March 31, 2023, including a long winning streak for the S&P 500, representing U.S. stocks, over the past decade. Negative numbers represent when the S&P 500 Index outperformed the MSCI EAFE Index in U.S. dollars over rolling three-year annualized returns. From January 1973 to December 1975, international stocks outperformed. From January 1976 to September 1977, U.S. stocks outperformed. From October 1977 to January 1981, international stocks outperformed. From February 1981 through July 1985, U.S. stocks outperformed. From August 1985 to February 1990, international stocks outperformed. From March 1990 to March 1994, U.S. stocks outperformed. From April 1994 to February 1996, international stocks outperformed. From March 1996 to July 2003, U.S. stocks outperformed. From August 2003 to January 2010, international stocks outperformed. From February 2010 to March 2023, U.S. stocks outperformed.

Sources: Capital Group, MSCI, Refinitiv Datastream, Standard & Poor’s. Relative returns are measured on an annualized rolling three-year total return based in U.S. dollars. As of March 31, 2023.

Going forward, I think balance sheets are going to matter more than ever, and I'm paying attention to that. Avoiding disasters is going to be as important, or maybe even more important, than finding the next big thing. And I believe it’s possible you may be able to generate solid returns investing outside the U.S.

One good sign is that I continue to have meetings with company managements where no one is super bearish. I just met with the executives of a large restaurant company. Are things great? No, but they’re good — and they expect to grow, even amid recession fears. I also met with the management of a semiconductor company. They said this may be a tough year, but they expect to grow five-fold over the next decade because of rising demand for computer chips.

In my view, there are three important things to keep in mind going forward: Valuations will matter. Balance sheets will matter. Avoiding disasters will matter.

And that might just be good enough.

Andrew Suzman is an equity portfolio manager with 30 years of investment experience (as of 12/31/2023). He holds an MBA from Harvard and a bachelor's in political economy from Tulane.

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