Q3 2024 Market Commentary - The Case for Global Diversification

• The S&P 500 powered to new highs in September and ended the quarter with a 5.6% total return.

  
  

• Central banks across the globe began an interest rate cutting cycle with hopes of skirting a recession and achieving a soft economic landing amidst decelerating cyclical inflation.

  
  

• We are seeing an attractive opportunity to diversify stock portfolios with a healthy exposure to overseas equities.

“Swiftonomics” and The Case for Global Diversification

For any non-“Swifties” out there, “Swiftonomics” refers to the economic influence of Taylor Swift, beloved by a large and diverse fan base of individuals from all walks of life. When Swift goes on tour, she is routinely credited with boosting the local economies she performs in, luring in fans from all around at massive scale that are eager to spend their money on concert tickets, food, transportation, hotels, and merchandise.

In 2023, Swift embarked on her Eras Tour, a series of 149 concerts spanning five continents that is still ongoing yet has already become the highest-grossing music tour on record, bringing in over $1 billion so far. Swiftonomics has been so powerful, even the Federal Reserve mentioned Swift in its June 2023 Beige Book, its regular analysis of recent economic conditions, stating that "May was the strongest month for hotel revenue in Philadelphia since the onset of the pandemic, in large part due to an influx of guests for the Taylor Swift concerts in the city." 

While her concert ticket prices have varied by city, the cost of a ticket in the U.S. is truly astronomical – exceeding multiple thousand dollars for a single ticket in the most popular cities. However, some budget conscious Swifties may find value by choosing a more cost-effective approach – packing their bags and traveling to Europe to see her perform for a fraction of the price.

To put this in perspective, Swift has a few more U.S. tour stops remaining before heading back overseas and the cheapest ticket available for her concert in New Orleans later this month is $1,732. The price to see her in Miami is a whopping $2,185[1]. While the reality is likely that some or many Miami concert goers will be flying in from out of state to see her, we have made the assumption that those planning to attend the Miami concert are all local residents. Despite the cost of an eight-hour flight to Europe and two nights in a hotel, it is considerably cheaper in most instances for someone in Miami to attend one of Swift’s concerts thousands of miles away than it is to drive down the street and see her locally!

All of this said, traveling halfway across the world to see a Taylor Swift concert simply because it would be cheaper than seeing her locally may seem silly for most of us. However, the underpinning concept of this story is relative value.

Just like it’s cheaper to see Taylor Swift in an overseas country than it is in the U.S., we see relative value and investment opportunity in overseas equities as compared to U.S. equities.

Long-Term Performance

U.S. investors have tended to have pessimistic views on investing in overseas equities. Many tend to ask, “why invest overseas when the past 10 years have been dominated by U.S. equities?”. With that, we do not disagree that U.S. equities have considerably outperformed overseas equities the past decade despite overseas equities still performing reasonably well.

However, many investors would be surprised to hear that when taking an even longer-term view, U.S. equity outperformance is just a relatively recent phenomenon. Both the U.S. and the rest of the world undergo decade-long stints of relative outperformance, yet over the longer-term, they have followed a similar trend. Considering the last decade of U.S. outperformance, this begs the question of whether diversifying in overseas equities is attractive. We believe that it is.

Why Overseas Equities?

Overseas equities make up roughly 20% of your RISE equities portfolio today. We have a favorable outlook on this asset class for four main reasons:

1.       Positive Macro-Economic Backdrop

2.       Local Currency Tailwinds

3.       Attractive Valuations

4.       Diversification Benefits

Positive Macro-Economic Backdrop

Overseas economic growth has not been stellar the past decade leading to relative underperformance. Notable reasons include fiscal austerity, secular stagnation, an over-valued U.S. Dollar, war and harsh COVID-19 lockdowns. While these concerns put considerable negative perception on the outlook for overseas economic growth, we believe a new chapter may be beginning to unfold.

COVID-19 and the Ukraine War have acted as key catalysts for foreign governments to kick their previous austerity habits and ramp up investments in cyclical industries. Whether it be energy, defense, or infrastructure, foreign policymakers are getting the memo that they must invest to face their critical challenges and end the era of secular stagnation. 

The U.S. Federal Reserve’s rate cuts should also lead to a weaker U.S. Dollar and enhance global dollar liquidity. Household and corporate debt overseas tend to have higher amounts of floating rate debt, whereas U.S. household and corporate debt is overwhelmingly fixed rate. Global rate cuts should disproportionately benefit overseas borrowers.

There is no denying that overseas economies such as Europe are most exposed to the war in Ukraine. However, should this geopolitical conflict reach a resolution, most notably with a potential new U.S. administration, Europe remains best positioned to benefit from Ukraine’s eventual recovery.

Local Currency Tailwinds

Overseas equities are priced in local currencies (i.e. Euros, Yen, Pound, etc.). When U.S. investors buy overseas equities, they are exposing themselves to these currencies. While a U.S. investor would succumb to foreign exchange risk if the local currency declined (USD appreciation), the U.S. investor would benefit should the local currency appreciate (USD depreciation).

Our view is that the U.S. Dollar is overvalued while most overseas currencies are undervalued. Relating this back to Swiftonomics, our budget conscious Miami Swifties would receive a cost benefit by converting their U.S. Dollars to British Pounds that they would pay to see Taylor Swift in London instead of Miami. We see similar currency tailwinds in financial markets, especially amidst a Federal Reserve rate cutting cycle where the U.S. Dollar tends to weaken relative to other currencies.[2]

Attractive Relative Valuations

Just as a Swifty would achieve a relative price “deal” to see the concert overseas, U.S. investors are receiving an even better deal by buying overseas equities. The table below reflects the relative valuation metrics of U.S. versus overseas equities.   

One common argument in favor of paying a premium for U.S. equities is that U.S. companies grow their earnings faster. U.S. equities are expected to grow their earnings by 14.3% over the next 12 months, versus overseas equities expected to grow their earnings at 10.9% over the same time period. However, investors have already priced in the higher expected earnings growth into U.S. equities valuations with a Forward Price/Earnings ratio of 22.1x as compared to only 13.5x for    overseas equities. It’s important to also consider the “PEG” ratio, which measures the premium an investor pays for that earnings growth. Through this lens, investors are receiving a far better deal owning overseas equities at a 1.2x PEG ratio versus U.S. equities at a 1.5x PEG ratio.

Since the turn of the century, U.S. and overseas equities have spent roughly half of the time trading at similar Price/Earnings valuations, whereas the valuation gap is now at the highest it has been in a generation [3].

We believe the historically wide valuation gap will begin to narrow with time, favoring overseas equities valuations while enjoying a 2.9% dividend yield.

Diversification Benefits

U.S. equities have come to overrepresent the global equity market, with U.S. equities accounting for a whopping 61% of global equity market capitalization despite being only 26% of global gross domestic product (i.e. Global GDP)[1].  The last time U.S. equities made up this much of the global equity market was in the late 1960’s, and that was followed by substantial overseas equities outperformance over the subsequent decade.

Diversification benefits from overseas equities also include less concentration risk and more diverse industry exposure.  The ten largest overseas companies as a proportion of the overseas equity market is 12%, significantly smaller than that of U.S. equities, as the U.S. equity market is dominated primarily by the largest players in the technology sector. The market capitalization weighted Wilshire 5000 index, regarded as the most inclusive representation of the total U.S. equity market, is composed of roughly 3,400 stocks. However, the ten largest companies in the index make up 30% of its market value.

Strategic Portfolio Positioning

We have conviction in the long-term benefits of overseas diversification in portfolio construction, and our core portfolio allocation framework is positioned accordingly with roughly 20% exposure to overseas equities. This is relative to the S&P 500 index with near zero exposure to overseas equities.

While we don’t anticipate traveling overseas to see Taylor Swift anytime soon, we believe there are abundant opportunities globally and that any equity portfolio would be incomplete without any consideration to equities outside of the U.S.

As we look ahead, remember that investing is not just about numbers or market fluctuations—it’s also about vision, patience, and conviction. Every market and market cycle offers unique opportunities for those who trust in the process, stay the course, and maintain a disciplined approach. We are planting seeds for your long-term wealth creation and success.

Footnotes and Disclosures

1. The Sporting News: Cost comparison for Taylor Swift Europe tickets plus flight vs. cheapest tickets for U.S. Eras Tour 2024.

   
   

2. Americans venturing overseas are recognizing just how cheap overseas assets are when converting their U.S Dollars to local currencies. Villages in Spain and Italy are littered with American tourists and new vacation homeowners, and we anticipate a record number of foreigners on Japanese ski slopes this winter for the same reasons.

   
   

3. Source: Verdad capital

*RISE Investment Management, LLC (aka "RISE Investments") is an Investment Adviser exempt from State registration. Advisory services are only offered to clients or prospective clients where RISE Investments and its representatives are properly licensed or exempt from licensure. This publication is solely for informational purposes and past performance is not indicative of future results. Any historical returns, expected returns, or projections are provided for informational purposes only. No advice may be rendered by RISE Investments unless a client service agreement is in place.