On a global basis, equity investments have pretty much been a zero sum game in 2018. Consider the following YTD returns of three large US listed exchange traded funds that track global and US-only indices:
- ACWI (iShares product that invests in global large/midcap names): +1.0% YTD
- ACWX (iShares product that invests in global equities, but excludes the US): -5.9%
- SPY (the largest S&P 500 tracker ETF): +7.1%
Almost all the performance differential between the S&P 500 and rest-of-world equities has come in the last 3 months. Over that time the S&P is +4.5% on a price basis while ROW is 6.9% lower. The difference – 11.4 percentage points – is 88% of the YTD total relative outperformance of US versus ROW equities in dollar terms.
It is easy enough to outline the reasons for this relative outperformance. US corporations are enjoying +20% earnings growth thanks to a strong domestic economy and tax cuts. Unemployment here is at/near record lows. US trade policy is aggressively pursuing revamped relationships with the rest of the world, spooking capital out of those markets until the new rule book is available on tariffs. Dollar strength puts pressure on exporters and also draws capital to US capital markets. Lastly, hopes for a spurt of global synchronized growth petered out sometime at the end of the first quarter.
The important question now is “When are rest-of world equities safe to own/overweight?” and to answer that we’ll dig into our toolbox and update you on our monthly “VIX of everything” analysis. The basic measure we use is the Implied Volatility of options tied to various sectors and asset classes, the same math as the VIX. Like the CBOE VIX Index, which signals buying opportunities when it spikes, we’re looking for signs of panic in ROW equities.
Here is the data that captures where non-US market sentiment currently sits, viewed through the lens of options prices:
- ACWX (whole world ex-US): a “VIX of” 15.8, just below (by 10%) the average of its 52-week high (24.8) and low (10.5).
- EEM (MSCI Emerging Markets Index): a “VIX of” 18.9, also just below (12%) the average of its 52-week high (31.7) and low (11.5).
- EFA (MSCI Europe, Asia, Far East developed economy index): a “VIX of” 11.1, notably below (29%) the average of its 52-week high (24.1) and low (7.0).
The upshot here is that there isn’t yet enough concern built into options/”VIX of” prices to signal a buying opportunity in rest-of-world equities. Emerging markets, despite their recent disappointing performance, simply do not show the classic signs of capitulation that a high “VIX of” reading would imply. And that goes double (literally) for EAFE stocks.
Flip this analysis around to look at US stocks and you’ll see notable complacency that the current “America only” sentiment will continue. Not only is the actual CBOE VIX Index at 12.5 (more than one standard deviation from its long run average of 19.6), but longer-dated options prices show similar low levels of Implied Volatility. At a current reading of 9.0 for the Implied Volatility of all listed SPY options, that is +50% lower than the one-year average of this measure’s highs (32.1) and lows (6.8).
The upshot here is that investors have a tough choice to make over the balance of 2018. Sticking with US equities means believing the status quo will continue. Starting to overweight rest-of-world is a bet that trade/tariff issues will begin to abate.
Our recommendation is to stick with US stocks for now. There just is not enough fear built into ROW equity prices at the moment.