For US financial markets, an inflection point is looming. In coming months, the Federal Reserve’s multi-year quantitative easing program will end – and with it, a profound source of support for stocks over the past six years.
How exactly US markets will behave as “QE” fades from the scene for good is, of course, unknowable. But from our vantage point as managers of BlackRock’s Global Allocation Fund, there seems little question that, when it comes to identifying the next opportunity for generating portfolio return, forward-thinking advisors and investors need to redouble their focus on markets beyond the U.S.
Today, there is ample reason to be looking to both Japan and Europe for such return -- with a discerning eye, however, since the macroeconomic fundamentals of both areas remain challenged and require investor patience. Each investment case has its own idiosyncrasies. But -- just as has been the case in the U.S. -- we believe that proactive monetary policy will be a key driver of the opportunities likely to emerge in both parts of the world.
Since 2009, US stocks have enjoyed an enviable run. But acquainting clients with the straightforward fundamentals likely to shape returns across markets going forward can help them understand why it might be time to rebalance toward stocks abroad.
We believe that Japan and Europe also can offer a useful counter-narrative to potential investor fears about investing far from home. Non-US companies today make up 54% of the world's market cap, but they collectively represent just 27% of U.S. investor assets. Indeed, in a recent BlackRock survey of 1,004 investors, about six in 10 agreed that “investing outside of the U.S. is too risky.”
By offering clients a look at the landscapes of both Japan and Europe today, an advisor can add powerful color to the time-tested and still valid benefits of maintaining an intelligently diversified, truly global investment stance.
Trimming US Exposure
Since 2014's start, we have systematically trimmed our U.S. stock allocation, to 24 percent of the portfolio at the end of August from 33 percent in January. It's not that we're "bearish" on the U.S. -- indeed, our U.S. stock allocation remains our portfolio's largest. Rather, what we see is that on a relative basis, certain overseas markets offer more attractive valuations.
Currently the S&P 500 trades at about 15 times forward earnings and about 26 times cyclically adjusted earnings - well above the historical average of 16.5 times. Lower capitalization US stocks are even more pricey: Mid-caps now trade at about 17 times forward earnings, and small caps at about 20.
QE is now in its late innings, but that is not the only factor muddying the U.S. case. Though U.S. corporate profitability has been excellent, we believe that it might now be near a cyclical peak. Furthermore, in recent decades, U.S. corporate managers have focused on squeezing higher ROE from balance sheets through aggressive financial management and now the potential for additional returns from this activity might be diminishing.
Today, we believe that all these drivers of equity return -- monetary policy, rising profitability, and focus on shareholder value -- have further to run in other parts of the world than in the U.S.