Expectations Remain Low for Overseas Stocks

Wall Street is all about expectations, and when expectations are too low, its easier for stocks to rise.

This was true for foreign stocks in 2017. Foreign economies easily outpaced low expectations, leading to strong corporate earnings and share price performance (top chart below). Non-US stocks rose 28% as measured by the MSCI All Country World EX US Index. The U.S. economy also exceeded expectations and stocks posted strong results, with the S&P 500 gaining 21.8 %.

What do investors expect for 2018? One way to gauge is to look at the price investors are willing to pay for stocks. High prices suggest high expectations, while low prices suggest low expectations. Today, the prices of international stocks are relatively low compared to their sales and earnings. Conversely, the prices of U.S. stocks are relatively high compared to their sales and earnings (bottom chart).

This suggests expectations remain lower overseas. Accordingly, we believe foreign stocks have more room to surprise to the upside in 2018. In the U.S., the outlook for economic growth and corporate earnings is quite bright. However, it will become increasingly challenging to exceed the lofty expectations already reflected in stock prices.

We recommend that investors continue to emphasize foreign stocks, particularly emerging markets, in the equity portion of their portfolio. We remain upbeat on U.S. stocks, but positioning in this area should reflect increasing risk owing to higher valuations.