“Things are going to change.” – Rick Schmidt, Harding Loevner Global Equity Fund, referring to the relative strength of US stocks
In our April 4th post Overboard US Stocks we profiled the absolute dominance of America’s equity markets versus their international counterparts over the past six years. As we stated, if there was ever a time to have gone overboard on your allocation to US Stocks, the past six years was it! However, we also pointed out that the relative strength in domestic equities has resulted in a market that is overpriced relative to its peers around the globe.
Virtually every measure of valuation in the US looks historically expensive and overinflated when compared to international stocks. Just this morning I saw a chart showing that the US stock market capitalization as a percentage of US GDP has hit an all-time record high. This was the measure that in 2001 Warren Buffet referred to as “probably the best single measure of where valuations stand at any given moment”. Assuming the Sage of Omaha is right, our domestic stock market appears frothy.
We believe 2017 may bring the winds of change in global equity leadership, with a shift in relative strength from US to international. The very thing (valuation) that is likely to act as a headwind to the US market, could very well be a tailwind for international markets that are trading on the cheaper end of the spectrum. So how does this conviction flesh itself out in our day to day asset allocation? As we stated in our April post,
Our methodology, of course, is to identify and get in line with the trend. …We will likely remain heavily tilted towards the US until after the relative leadership shift has been established, at which point we could, in theory, shift 100% into foreign markets.
Since writing those words in early April we have seen a pronounced shift within MarketVANE away from the US into foreign stocks, with the target allocation tripling from 20% to 60%. The chart below reflects MarketVANE’s percentage exposure to international stocks since inception in mid-2014. Target exposure has remained depressed at 0-20% for the vast majority of the past three years, and while it climbed to 60% on two separate occasions it quickly reversed course both times. With our mid-June update international exposure jumped back up to 60% - and this time we think it has a good chance of sticking.
The stable of ETFs eligible for trading within MarketVANE includes nine US sector and six international funds. As such, there is a natural tilting towards the US that is likely to occur over time given the fact that there are simply more potential US-centric options active in the model. That said, if the US ever fell from favor and became the world’s laggard, MarketVANE could, in theory, move 100% into foreign exposure. This is a key differentiator vs a more static indexed approach.
Looking specifically at one of the six international components within MarketVANE, the MSCI All-Country World ex-USA Index ETF (ticker CWI), the chart below shows that since MarketVANE went live in mid-2014 we have not owned this fund once. That changed just a couple of weeks ago with our mid-June update. This ETF has clearly been in an uptrend over the past eighteen months, and that trend recently became pronounced enough to overtake US Industrials, a position we’ve had in portfolios since last November.
In addition to the above ETF, we also hold an International Currency-Hedged and a Europe-specific ETF in equity portfolios. The three international components that we don’t (yet) own are Japan, Asia ex-Japan and Emerging Markets.
As a matter of practice we prefer to rely on the disciplined and systematic process inherent in MarketVANE’s trading methodology rather than our gut level convictions when it comes to allocation decisions. That said, we are generally pleased to see more of our global equity exposure rotating away from the US where valuations seem too rich. Valuation, of course, is not the sole driver of equity returns, but starting valuations are certainly an important consideration - especially over long time horizons. As Rick Schmidt predicted in the opening quote, “Things are going to change.” Indeed, the winds of change already appear to be blowing, and thus far MarketVANE is changing right along with them.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.