Over the last decade, U.S. equities have not only significantly outperformed equities from other parts of the world, they’ve done it with lower volatility and without regard for fund manager talent, according to a new report from Morningstar.
One look at Morningstar’s own indexes shows that the best-performing actively managed foreign large-blend fund trailed nearly all active U.S. large-blend funds over the ten-year period following the 2009 global financial crisis.
From 2010 to 2022, the Morningstar U.S. Market Index gained 12 percent annualized, compared to the Morningstar Global ex-U.S. Index’s 4.4 percent. Emerging markets struggled the most, with the Morningstar Emerging Markets Index gaining just 3.0 percent over the same period. However, Morningstar found that developed foreign markets also trailed the U.S. markets. From 2010 to 2022, the Morningstar Developed ex-U.S. Index gained just 4.6 percent annualized.
And while Morningstar noted that exchange rates and the currency market may have played a small role in exacerbating these divergences, many other foreign currencies, including the euro and Japanese yen, have appreciated at a similar rate. “No matter how it’s measured, U.S. equities have reigned supreme,” Morningstar wrote, adding that the U.S. indexes were less volatile than their foreign counterparts while maintaining “superior absolute returns,” due in part to the U.S. market’s size.
The U.S. index is made up of about 1,500 U.S. stocks, in contrast to the British, Canadian, Australian, German, French, and Dutch indexes, all of which have less than 300 holdings and are far more concentrated in their top holdings, according to Morningstar. Only Japan, with nearly 1,000 holdings in its index, was meaningfully less volatile than the U.S., although Japan’s returns came in far below that of the U.S. market, with just 4.9 percent in annualized gains.
Despite traditional assumptions, the Morningstar report said that the U.S. markets have defied “the textbook, capital asset pricing model logic that more risk should come with higher expected returns.” Furthermore, the superior returns aren’t due to a lack of high-performing international companies — according to Morningstar, more than half of the best-performing 500 stocks from 2010 through 2022 were from outside the U.S. However, more than 80 percent of the worst-performing 500 stocks were based overseas, which dragged international-focused indexes down.
There are many reasons for the U.S. advantage over the past decade.
The U.S. is the world’s most competitively advantaged market, Morningstar said. The country is the center of global innovation, and it has far more exposure to technology and communication services, which comprise about 30 percent of the U.S. index, more than double that of the non-U.S. index weighting. Meanwhile, financial services made up the largest portion of the non-U.S. index (20 percent), followed by industrials at 13 percent.
Additionally, the best-performing U.S. companies were larger on average than their non-U.S. counterparts, which magnified their impact on weighted benchmark returns. From 2010 to December 2022, the Morningstar Global Financial Services Index grew at an annualized rate of 6.1 percent, while the Morningstar Global Technology Index gained an annualized 12.7 percent.
Despite the gains from U.S. indexes, however, active managers on average have become less optimistic about U.S. stocks in recent years. In 2010, the median global equity manager held 46 percent in U.S. stocks, 5 percent more than the global equity index exposure of 41 percent at the time. As of December, 59 percent of the stocks held by median managers were U.S. companies, matching but not beating the exposure of the global index.
It’s impossible to say what the future performance of market indexes will hold, but according to Morningstar, many scenarios could lead to a foreign market resurgence: improved corporate governance, relative earnings growth — a key driver of equity market performance —a weakening dollar, and non-U.S. stocks simply reverting to the mean.
“Perhaps the strongest rationale for a non-U.S. equity resurgence is the market’s most pervasive phenomenon: mean reversion. Market history is defined by cycles, rotations, and changes in leadership,” Morningstar wrote. After all, non-U.S. stocks outpaced U.S. stocks for an extended period in the mid-’80s, as well as from the late 1990s into the mid-2000s.
“If history is a guide, most companies that grow to dominate benchmarks struggle to stay there,” said Morningstar. “Many of the risks that could undermine continued U.S. market leadership present opportunities for non-U.S. markets. Non-U.S. stock valuations and currency levels appear relatively attractive. Closing the gap in fundamental performance and corporate governance with their U.S. counterparts could be catalysts for non-U.S. stocks. But that does shift the onus to foreign companies to perform better — otherwise, such a bet could become a value trap.”
