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Is it time to invest in U.S. stocks over Foreign stocks?

Recently, a friend was curious about investing in a U.S. stock index fund, based on the higher returns U.S. equities generated over the past few years compared to stocks from other countries. Indeed, as of the end of 2017, the S&P 500 index returned over 15% average annualized over the last 5 years, well above most developed countries’ stock markets. To many people, even most followers of financial markets, it may feel like U.S. stocks constantly outperform other stocks these days. However, as Meb Faber, of Cambria Investments, explains in his white paper “The Trinity Portfolio”, whether U.S. stocks do better than their international peers in any given period is actually more of a crap shoot. Each performs better than the other about half of the time.

Even looking over longer periods of time yields a similar picture. For example, it was only in January 2015 that the 10-year average return of the S&P 500 surpassed that of the S&P TSX Capped Composite, Canada’s most followed stock index.

Using MSCI’s methodology and data on country stock market returns, I looked into U.S. stock returns versus that of other countries over trailing 10 year periods, looking each month up until December 2017. The resulting graphs follow. The way to read these is that if U.S. stocks outperformed that country’s stocks over the previous 10 years at that date, then the graph is above 0. Below 0 means the foreign country’s equities performed better than American equities.

Source: MSCI

From these charts, it can be seen that the current outperformance of U.S. stock markets compared to other countries’ markets is relatively recent. In the past, these periods of over- and underperformance ocurred at similar frequency, and often they were surprisingly long and deep. For instance, if you looked at U.S. stock returns versus Canadian stocks at the end of July 2008, the former had at that point underperformed the latter by 13% annualized over the previous 10 years.

So when will the current cycle of U.S. stocks outperformance turn? That is impossible to say, it can last for a long while still. However it should be noted that U.S. stocks appear to be more expensive than stocks from other countries or regions. Generally, a stock market will perform poorly going forward when it’s trading at very high ratios, which seems to be the case for U.S. equities. In light of that, and the likelihood that U.S. stocks outperformance will eventually revert even if we don’t know exactly when, if there is a reasonable option available (unfortunately my friend didn’t have particularly good options), I recommend diversifying investments globally.