International equities are having a moment—and it’s been 16 years in the making. Meanwhile, developed markets might be passing the torch to emerging markets.
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International equities are having a moment—and it’s been 16 years in the making. The iShares MSCI ACWI ex US ETF (ACWX) is outpacing the S&P 500 (SPX) by 10.8% so far this year. Assuming current numbers hold, ACWX’s double-digit excess over SPX is the strongest showing for international stocks through Q3 since 2009, meaning someone born during the last period of outperformance could be learning to drive today.
While the overall strength in international equities has been impressive, the underlying drivers have been even more encouraging. The rise in international stocks has been bolstered by developed and emerging markets alike, with the iShares MSCI EAFE ETF (EFA) and the iShares MSCI Emerging Markets ETF (EEM) each gaining more than 20% YTD. Given the hot streak through the first three quarters, should we expect the performance to carry over into the next quarter and beyond?
There have been four other instances in which both EFA and EEM have gained more than 15% through Q3. In each case, both funds posted gains the following quarter, with EFA averaging a 4.9% return while EEM surged ahead with a 15% average return. One-year returns were more modest, averaging just a few percentage points higher, but were still positive overall. Granted, it’s a very limited sample, but it does support the notion of continued strength, particularly within emerging markets.
The breadth of strength in international equities has been strong this year, but we’ve recently seen emerging stocks move ahead of their developed counterparts. After going toe-to-toe for much of the year, EEM has bested EFA by more than 5% over the last month. This shift has boosted emerging markets' relative strength, with EEM reclaiming near-term leadership over EFA on their RS chart. Following the fund in an RS column of Xs has historically been a positive signal, outperforming both EEM and EFA over time, demonstrating the relationship’s value. EEM also holds a fund score of 5.51 with a sharply positive score direction of 3.60. Meanwhile, EFA holds a respectable fund score of 4.03 and a negative score direction of -0.51, both of which lag EEM. In fact, the ~1.5 difference in fund score between the two is at its widest margin since October of last year, with a full point of the widening taking place in September alone. Given the shift, emerging markets could be taking the wheel of international leadership from developed markets. That said, investors should stay buckled in for the months ahead, as the group sits in overbought territory and has been prone to sharp movement this year.
Domestic equities continue to sit first in our DALI asset class ranks, but international equities remain close behind for now. Given the rise of international markets, foreign equities warrant a place in many portfolios, with emerging markets deserving extra attention for now.
