Much attention has been given to the high-velocity rebound in U.S. stocks from their December 2018 lows, and rightly so. Progress in U.S.-China trade talks, a welcome shift in sentiment at the U.S. central bank, and a much-needed easing of financial conditions have helped propel U.S. equities higher by 14% year to date.1
With the S&P 500 Index now within 100 points of its all-time high reached in September 2018, some investors are understandably wondering if the rally has gotten a little ahead of itself and whether some temporary turbulence is approaching.
One technical indicator suggests U.S. stocks are looking overbought in the short term. The percentage of S&P 500 constituents above their 50-day moving average hit 92% in February 2019, the highest reading in over a year. Exhibit 1
It’s important to note that both selloffs in February and the fourth quarter of 2018 were preceded by similarly overbought technical extremes, namely high percentages of stocks greater than their short-term moving averages.
When U.S. Stocks Are This Overbought, International Stocks Outperform
If some near-term volatility is indeed approaching for U.S. share prices, what would it mean for international equities? Said differently, if U.S. stocks sneeze, will Chinese and emerging market (EM) stocks catch a cold?
No, not necessarily. A look back at recent equity returns is instructive.
Recall that the S&P 500 Index experienced a 10% correction in February of last year, culminating in a negative first quarter of 2018. Meanwhile, the MSCI China and Emerging Markets indices were both up over 1% in the same period.
True, U.S. stocks recovered sharply while Chinese and EM stocks plummeted in the second and third quarters of 2018, but the inverse pattern held.
At the end of last year, the S&P 500 Index suffered a bear market decline of roughly 20% before hitting bottom on Christmas Eve. However, the MSCI Emerging Markets Index troughed two months before in October 2018, helping it outperform its U.S. counterpart by more than 6% in the fourth quarter.
Currently, Chinese stocks are back in a cyclical bull market—having soared 24% from their lows—and outperforming U.S. stocks by more than 5% year to date.
Buy the Dips in U.S. Stocks, or Raise International Equity Allocations?
The bottom line is that the relationships between these markets aren’t hard and fast—they ebb and flow over time. In fact, the correlation of U.S. and international equity returns has been falling from a high level, as they did from 2008 to 2014, from 2003 to 2007, and from 2001 to 2003. Exhibit 2
As market correlations fall, the benefits of international diversification increase. Instead of buying a potential dip in U.S. stocks, perhaps investors should consider selling into recent strength and adding to their international equity allocations.
Check back in April for a bi-annual update of our views in the Equity Strategy Playbook.
The Equity Strategy Playbook leverages our resources as a leading global asset manager, including decades of research experience, to gather and present the indicators that matter most for equity performance in a visual and digestible format. Our multifactor framework for equity portfolio positioning is a consistent, systematic method that’s well-suited for thematic, big-picture investing. Investors can use this straightforward, transparent framework to see how we arrived at our conclusions, and to form their own.
Correlation measures the degree to which two markets move in relation to each other. It is expressed as a coefficient with a value between +1 and -1, where +1 indicates perfect positive correlation and -1 indicates perfect negative or inverse correlation.
The S&P 500 Index measures the performance of 500 U.S. large market capitalization stocks, and is intended to be a representative sample of leading companies across many industries within the U.S. economy.
The MSCI USA Index captures large and middle market capitalization equity performance of the United States.
The MSCI ACWI ex USA Index captures large and middle market capitalization equity performance across EM and DM countries, excluding the United States.
The MSCI Emerging Markets Index captures large and middle market capitalization equity performance across 24 emerging market (EM) countries, including Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates.
Indices are unmanaged and cannot be purchased by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any particular investment. Past performance does not guarantee future results.
- ^Source: Bloomberg. Note: Net total returns in U.S. dollars as of 3/18/19.
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