The last couple of years have proven to be rather miserable for international stocks.
From the beginning of 2013 to the end of 2014, equities around the world trailed the S&P 500 badly. One index that focuses just on European stocks lagged its U.S. counterpart by more than 13 percentage points annually.
This year, however, the rolls have reversed.
Despite ongoing fears over recessions and deflation in many parts of the world, total returns this year for both the MSCI EAFE index of developed-market stocks and the MSCI Emerging Markets Index have quadrupled the gains for the S&P 500.
What’s going on? And what should you do about it?
Viewed from one perspective, it may seem odd that European equities have performed so well. After all, Europe and Japan aren’t out of the economic woods just yet, and the U.S. has beaten its developed market peers in the last few years with regard to economic growth. Absolute levels, though, matter less than the trend.
“Remember that stock market performance does not closely track economic performance,” per Gregg Fisher of GersteinFisher. “Rather it is often more sensitive to the direction of economic change, shifting market sentiment and valuations.”
On that front, things are looking up abroad.
The massive $1.1 trillion bond-buying program undertaken by European Central Bank President Mario Draghi has started to bear fruit. Gross domestic product grew by 0.3% in the last three months of 2014, boosted by Germany and Spain, as commercial banks are starting to increase lending.
The slide in the euro’s value against the dollar has also made European exports more competitive, while low energy prices globally have put more money in consumers’ pockets. While consumer prices fell again in March, the fourth consecutive drop, the decline was smaller than previous months, while the unemployment rate slightly improved.
Risks still remain (see: Greece leaving the euro), but a slight glimmer of optimism has returned the eurozone. And this is a good thing for globally minded investors, especially those looking to buy inexpensive fare.
“As Europe begins its recovery, its stock valuations appear attractive compared to U.S. equities,” per BlackRock’s Heidi Richardson. The price/earnings ratio for U.S. stocks trades at 17.7, compared to 13.8 for Euro-focused Money 50 fund Oakmark International .
Look to Oakmark or another Money 50 selection Fidelity Spartan International to gain exposure to Europe. A good rule of thumb is to allocate about one-third of your stock portfolio to international equities.
With Draghi committed to quantitative easing until fall of next year, and stocks still available at value prices, now’s the time for investors to truly embrace diversification.