US stock market's record highs prompt investors to reevaluate global options

The relentless surge of the US stock market to all-time highs is prompting investors to reassess their portfolios, considering the substantial valuation premium of American equities compared to their global counterparts. With a 24 per cent gain in 2023 and an additional 2 per cent increase in 2024, the S&P 500 has maintained its position as a leader among key regional indexes.

Investors, however, are becoming increasingly conscious of the widening valuation gap between the S&P 500 and MSCI's index encompassing stocks from over 40 other countries, now at its widest in over two decades. This has led some investors to explore international markets for potentially more attractive returns.

Despite the S&P 500's heavy tech sector weighting and better economic and earnings prospects for the US in 2024, concerns arise as the index trades at nearly 20 times forward earnings estimates, well above its long-term average. In contrast, MSCI's all-country world index (excluding the US) is trading at 12.8 times, close to its widest gap in over two decades.

International equity funds witnessed $73.6 billion in net inflows in 2023, while US equity funds experienced $52.1 billion in net outflows, reflecting a growing interest in diversification. Jeff Kleintop, Chief Global Investment Strategist at Charles Schwab, notes, "Most people are probably underweight where their long-term allocation to international (stocks) should be, and now is the time to consider upping that."

The US advantages, including higher GDP growth and anticipated corporate earnings, are reflected in the market premium. Vanguard's economic models project US equity returns over the next decade at an average annual rate of 4.2 per cent to 6.2 per cent, while non-US developed markets and emerging markets are expected to yield higher returns.

Despite Japan's Nikkei rallying to 34-year highs and recommendations to "overweight" Japanese equities, some investors remain cautious about international developed markets, citing the need for more than just cheap valuations to spark interest.

(With Reuters inputs)