“I skate to where the puck is going, not where it has been.” – Wayne Gretzky
2017 has brought smooth sailing for investors, with U.S. and international equities delivering very strong returns. Positive investment returns have come in spite of disarray (to put it gently) in Washington D.C. Looking at the news each day, you would be hard pressed to believe that the S&P 500 is up 11.42%, YTD, while international stocks, as measured by the MSCI ACWI Ex US index, have returned 18.92%. The startling disconnect between political volatility, which seems to only increase, and market volatility, which seems to only decrease, has investors forgoing enthusiasm over the past and anxiously awaiting what lies ahead.
However, low volatility in of itself does not beget high volatility in the future. In a recent research report, BlackRock puts the dynamic as follows: “the history of volatility is one of long stretches of calm punctuated by brief moments of crisis.” Simply because we are in a period of quiet markets does not mean that the ugliness is lurking around the corner. BlackRock goes on to note that markets are typically either in a low or high volatility state, with high volatility regimes rarely occurring without an economic expansion coming to an end. Though the expansion is certainly in the later stages, we have not seen warning signs that it is likely to come to a halt in the very short-term.
What warning signs would we look for? First and foremost, we look to the labor market for indications on the economy’s health. Labor market data provides a real time, frequently updated look at the wellbeing of the economy that provides insight into both business and consumer spending. One critical data point we monitor closely is weekly jobless claims, a gauge of the number of people filing for unemployment insurance. At present, the weekly reading of initial claims stands at 244,000 vs. a historical average reading of 357,000 and a current expansion average of 351,000.
Simply put, the number of people filing for unemployment benefits is very low relative to historical averages and is trending downward. Jobless claims have continued to trend lower and as of the most recent reading (end of July) are down 8%, year over year. Until the trend begins to move higher, or consistently reads above 300,000 a week, we do not see a reason to be concerned. Other readings on the job market confirm that the economy is good shape. For instance, the unemployment rate currently sits at 4.4%, below its long-term average of 5.8%. Though many data points help guide our thinking about the overall economy, jobs data is one of the most important and it is not sending a warning signal yet.
However, investors must still look to position their portfolios for where the puck is going, not where it has been. While the U.S. economic expansion remains fairly healthy, it is in its later stages. Conversely, economic growth in Europe is in the middle innings with a greater runway than the U.S. Plagued by austerity, the Greek debt crisis, and political tensions, Europe has lagged the U.S. in recent years, despite a long history of keeping pace.
The gap in earnings performance shows itself in historical equity returns. For instance, the SPDR S&P 500 ETF (SPY) has returned 10.76%, annualized, over the last three years. By comparison, the iShares MSCI ACWI Ex US (ACWX), a gauge of international developed companies, has returned just 2.50%, annualized. While international and U.S. stocks generally provide similar returns over a very long time period, the recent degree of underperformance is significant.
Investors must keep in mind that yesterday’s leader is often tomorrow’s laggard. The upside potential for European corporate earnings, combined with improving economic growth in the continent, are signaling to us that investors should look for potential outperformance from international equities going forward. This has started to play out this year, with the ACWX ETF returning 18.92% YTD, through the end of July, compared to a YTD return of 11.92% from the S&P 500 ETF. Given the aforementioned factors, we think outperformance vs. U.S. equities could continue going forward.
Investment Advisory services offered by Independent Financial Partners (IFP), a Registered Investment Advisor. Wharton Hill and IFP are separate entities. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
All index and market data is via Morningstar, unless otherwise noted. Trailing returns is as of 8/31/2017 unless otherwise noted.