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Should I Invest in International Stocks in 2021?

Should I invest in international stocks in 2021? This is a common question on investor’s minds after U. S. stocks fared better than international stocks in 2020. In this post, I compare the valuation of stocks and prospects for growth in the U. S. versus those in international markets. I also analyze the potential for changes in currency exchange rates impacting international stock returns and answer the question: Should you invest in international stocks in 2021?

Although the year 2020 will long be remembered for COVID-19’s heavy toll on human life, the year will not be remembered as a bleak one for financial markets.

Every major type of investment or asset class ended above the flatline last year, despite being deeply in the red at the end of the first quarter.

U. S. stocks led the recovery. The MSCI USA Index designed to measure the performance of the large and mid-cap segments of the U. S. market rose 21.4%.

Developed international markets and emerging international markets advanced. Yet, they were unable to outperform U. S. stocks.

Developed market stocks as measured by the MSCI EAFE Index gained 7.8% in U. S. dollar terms last year.

Emerging market stocks as measured by the MSCI Emerging Markets Index gained 18.3% in U. S. dollar terms.

Should I Invest in International Stocks in 2021: Valuation Perspective

The underperformance of international stocks vis-a-vis U. S. stocks in 2020 has enhanced their appeal from a valuation perspective.

According to MSCI, stocks in the MSCI EAFE Index and MSCI Emerging Markets Index trade at a forward price-to-earnings ratio of 17.0 and 15.7, respectively.

In comparison, stocks in the MSCI USA Index trade at a forward P/E ratio of 22.7.

Should I Invest in International Stocks in 2021: Growth Perspective

The World Bank expects the global economy to grow 4.0% in 2021 after contracting 4.3% in 2020.

The recovery is expected to be broad-based with all regions showing year-over-year improvement in growth. The recovery will depend on the evolution of the pandemic, which will in turn be influenced by the effectiveness of the vaccination programs.

Should I Invest in International Stocks-Growth Perspective

The world economy is expected to grow 4.0% in 2021 after contracting 4.3% in 2020. The recovery is expected to be broad with all regions showing year-over-year improvement in growth.

Advanced economies are projected to grow 3.3% in 2021 after contracting 5.4% in 2020. The U. S. economy is forecasted to grow 3.5% this year after contracting 3.6% in 2020. The contraction was 1.0% point larger than in 2009, despite substantial financial support to households.

The pandemic’s impact on European economies has been severe compared to the U. S. European economies shrank 7.4% in 2020 as services sectors such as tourism that are vital to continental economies stayed depressed. The World Bank forecasts European economies to grow 3.6% this year.

Growth in emerging economies is seen strengthening to 5.0% in 2021 after falling 2.6% in 2020. The recovery is, however, likely to be uneven and quite dependent on China. Effective pandemic control and public investment-led stimulus helped China to buck the pandemic and grow 2.0% in 2020. China’s growth is likely to accelerate to 7.9% this year from pent-up demand.

Benefiting from higher growth, companies in emerging markets are forecasted to grow their earnings at a faster clip than those elsewhere in 2020. According to Refinitiv, earnings for companies in emerging and developed markets are estimated to grow 36.9% and 35.3%, respectively compared to 22.7% for companies in the U. S.

Should I Invest in International Funds in 2021: Currency Conversion Perspective

According to Federal Reserve Economic Data, the trade-weighted dollar index lost 5.6% versus advanced country currencies and gained 0.3% versus emerging market currencies in 2020.

As COVID spread to various parts of the world in the first quarter of 2020, the U. S. dollar gained versus foreign currencies due to its safe-haven appeal.

The dollar lost favor in the latter part of 2020, weighed by concerns of ballooning budget and current account deficits in the U. S. and expectations of strong post-COVID recovery in the rest of the world.

The sentiment towards the U. S. dollar has improved with the change in the regime in Washington.

The Biden administration is moving forward with the $1.9 trillion stimulus proposal to aid U. S. economic recovery.

Currency traders believe this stimulus will lead to stronger growth and higher inflation in the U. S. Stronger growth and higher inflation should, in turn, support the U. S. dollar by bringing forward the timetable for interest rate normalization.

The CME Group currency futures show traders expect the dollar to decline fractionally versus developed market currencies in 2021. The quotes show the dollar falling 0.3% vis-a-vis the euro and staying flat vis-à-vis the yen.

Traders, however, expect the dollar to gain versus emerging market currencies. The quotes show the dollar gaining between 2% and 4% vis-à-vis the Chinese yuan, Indian rupee, and the Mexican peso.

Should I Invest in International Stocks in 2021: Bottom Line

Developed as well as emerging market stocks have lagged U. S. stocks over the past 5- and 10-year timespans.

Over the past 5 years, MSCI USA Index is up a cumulative 108% compared to 43% and 83% for the MSCI EAFE Developed Market Index and the MSCI Emerging Markets Index, respectively.

Likewise, the MSCI USA Index is up 274% over the past 10-years while the MSCI EAFE Index and the MSCI Emerging Markets Index are up 71% and 43%, respectively.

International stocks have outperformed U. S. stocks in only two of the past 10 years. After this extended stretch of underperformance, expectations for international stocks are low and they are more attractively priced compared to U. S. stocks.

Attractive valuation supports the possibility of international stocks delivering above-average long-term returns and positions them to outperform U. S. stocks over time.

However, superior valuation metrics alone do not necessarily translate into superior short-term results.

So, what will it take for international stocks to outperform U. S. stocks in 2021?

International stocks tend to be more sensitive to global growth than U. S. stocks.

If interest rate policies of foreign central banks such as the ECB and BOJ bear fruit and accelerate growth abroad in 2021, international stocks should fare better than U. S. stocks.

So, should you invest in international stocks in 2021?

The answer is Yes.

Now is not the time to give up on international investing. If anything, now is the time to increase allocation to international stocks and international funds.

International stocks are due to provide superior returns compared to U. S. stocks. Whether 2021 turns out to be such a year depends on whether global growth accelerates this year.

 

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