Foreign Stocks Are Far Outpacing U.S. Stocks. Will it Last?

Foreign stocks, especially European stocks, have widely outperformed U.S. stocks in the last few months. Mitch takes a closer look at what's behind this shift. [Mitch on the Markets] Foreign Stocks Have Been Outperforming, But Will It Last? Non-U.S. stocks have been in rally mode. In the three months ending January 31, foreign stocks as measured by the MSCI ACWI ex-U.S. index have risen over +18%, while the S&P 500 index is up a much lesser ~4% over the same period. Foreign stocks widely underperformed U.S. stocks in the last bull cycle, so investors are naturally wondering if a trend reversal is underway.1 I’ll dig more into that question below. But first, let’s take a quick look at what’s driving recent foreign outperformance.2 One key driver has been the U.S. dollar. It is no coincidence that over the same period of time that foreign returns have been far outstripping U.S. returns, the U.S. dollar has weakened significantly from peaks. A weaker dollar means that foreign stocks will fetch more dollars once they are converted from their home currency, which increases their value. And compared to a basket of other developed foreign currencies, the dollar has fallen to June 2022 levels as seen in the chart below: --------------------------------------------------------------- [Should You Be Bullish? Get the Answer with Our Just-Released Report!]( Instead of basing your investment decisions on worrisome headlines, I recommend focusing on fundamental drivers. To help you do this, I am offering all readers our just-released Stock Market Outlook report. This report contains some of our key forecasts to consider such as: - Setting U.S. return expectations for 2023 - Zacks forecasts at a glance - What produces 2023 optimism? - What’s alive for 2023 pessimists? - Is it time to buy stocks? - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [IT'S FREE. Download the Just-Released February 2023 Stock Market Outlook 3]( --------------------------------------------------------------- Nominal Broad U.S. Dollar Index [MOTM_02042023_graph1] Source: Federal Reserve Bank of St. Louis 4 Another reason for U.S. underperformance relative to foreign has to do with technology weighting. Tighter financial conditions and higher interest rates have led investors to shun high P/E growth stocks, many of which reside in the technology sector. At the end of 2022, technology stocks made up about 26% of the S&P 500, compared to about 11% of the MSCI ACWI ex-U.S. index. In recent months, technology has not served as a major drag on foreign returns, as they have in the U.S. Finally, there are fundamental drivers that have made foreign stocks – particularly in Europe – attractive relative to the U.S. Heading into winter, there were acute fears that gas rationing and mandated industrial shutdowns across Europe – a byproduct of the war in Ukraine – would have a severe impact on economic output. In the fall, credit and equity markets were pricing-in weaker earnings and potential defaults. But in a classic “not as bad as feared” scenario, Europe was able to obtain sufficient natural gas supplies from other countries and trading partners; they enacted fiscal policies to provide consumers relief; encouraged households and businesses to curb consumption; and in a positive surprise, experienced warmer winter weather which helped keep demand at reasonable levels. All told, Europe expanded when most thought it would contract, delivering upside surprises across key metrics like consumption and wage growth. And not only did Europe grow in 2022, but it also expanded at a faster pace than the U.S. and China – the first time that’s happened since 1974. The currency bloc known as the eurozone posted 3.5% GDP growth for 2022, which outpaced the U.S.’s 2.1% and China’s 3% growth. This outcome surprised investors accustomed to seeing China lead, followed by the U.S., with Europe usually struggling to keep up. Stronger growth has contributed to good performance, and it helps that European stocks trade at a discount to U.S. stocks. But that’s not necessarily a strong thesis to abandon U.S. stocks for foreign ones. For much of the last bull market, the S&P 500 traded at a premium to many foreign indices and widely outperformed. I also think many of the forces helping European stocks could be temporary – the dollar could strengthen in the new year, European growth could stall as the European Central Bank continues raising interest rates even as the Fed pauses, and the U.S. and China could experience a growth rebound in the second half that outstrips Europe’s expansion. Bottom Line for Investors Over the past 10+ years, U.S. stocks as measured by the MSCI USA have greatly outperformed foreign stocks as measured by the MSCI EAFE. Cumulatively, the outperformance of the U.S. over foreign has been +212% from the beginning of the 2009 bull market through the end of last year – a fairly staggering figure. Leadership tends to change hands over time, but in the current environment, I think central banks could play a key role. The Federal Reserve is nearing the end of its interest rate hike campaign, while the European Central Bank likely has several hikes yet to go. China’s economic reopening could thrust it back into the lead in terms of annual growth in 2023, but U.S. stocks could come back into favor as the peak in the interest rate cycle becomes clearer. Time will tell where leadership emerges, but I’m not convinced that now is a time to pivot away from the US in favor of foreign. To help investors focus on data that can better impact their investments this year, I am offering all readers our [Just-Released February 2023 Stock Market Outlook Report](. This report will provide you with key forecasts along with additional factors to consider, such as: - Setting U.S. return expectations for 2023 - Zacks forecasts at a glance - What produces 2023 optimism? - What’s alive for 2023 pessimists? - Is it time to buy stocks? - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [Download the Just-Released February 2023 Stock Market Outlook 5]( About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. 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