US stocks have consistently outperformed their international peers over the past three decades, but AQR Capital Management cofounder and chief investment officer Cliff Asness believes the streak may be coming to an end.
“In retrospect, the outperformance of the US since 1990 can be largely explained by relative enrichment against other equity markets,” the billionaire investor wrote in a article with The Journal of Portfolio Management released on April 28, which illustrates how American stocks have become more expensive compared to their international counterparts. “Investors betting on continued US outperformance may be making a risky assumption that this enrichment will continue, despite historically high estimates suggesting the opposite is more likely.”
Asness is big on portfolio diversification, which has been shown to improve long-term returns. He argues that US investors should look to international stocks to diversify their portfolios because they show strong relative value based on cyclically adjusted price-to-earnings (CAPE ) ratios. the CAPE ratio, coined by Nobel Prize-winning economist Robert Shiller in 1988, has long been one of investors’ favorite ways to gauge whether stocks are cheap or expensive. It seeks to average out the peaks and troughs that naturally occur in corporate earnings by looking at the 10-year average of profits, adjusted for inflation, giving investors a more accurate measure of relative value.
A comparison of the CAPE ratio for the MSCI USA Index—which tracks large and midcap US equities, and the MSCI EAFE Index—which tracks large and midcap equities across 21 developed countries in Europe, Asia, Canada, and Australia, Asness saw US stocks trade. at record high valuations relative to their international peers by 2021, and remain close to those levels even today. And “valuations count,” argued the hedge funder. “Research shows, and simple economic logic will support, that countries that trade at lower valuations (lower price fundamentals) should have higher long-term expected returns.”
It might make sense to heed Asness’s call, too, because the hedge funder has had a career full of repeated successes. Starting with Goldman Sachs The “quantitative research” desk of Asset Management in the early ’90s while completing a Ph.D. in finance at the University of Chicago, Asness helped develop a mathematical approach to investing that used models to identify patterns in markets.
In 1995, Asness’s group started an internal hedge fund at Goldman that returned 140% to investors in its first year. The fund was eventually launched to the public as the Goldman Sachs Global Alpha Fund, and in just two years Asness headed a quantitative research group that managed $7 billion within the firm.
Asness then took his mathematical approach to investing at AQR Capital Management in 1998, co-founded the firm with David Kabiller, John Liew, and Robert Krail and grew it into one of the largest hedge funds in the world. In 2011, luck detailed AQR’s transition from a quantitative hedge fund for institutional investors only to an investment firm that also offers mutual funds and private funds for the average consumer.
It wasn’t always smooth sailing for Asness, however. After a long period of subpar returns between 2018 and 2020, some investors FLED AQR in 2021. But the hedge funder proved his ability last year.
The S&P 500 may have fallen nearly 20%, but several AQR funds managed a record performance, Bloomberg reported in January, citing unnamed sources. The Equity Market Neutral Global Value and Global Macro strategies, for example, returned 44.7% and 42.0% net of fees, respectively. And AQR’s longest-running strategy, called Absolute Return, returned 55% before fees last year, its best since 1998.
Asness is not alone in his view that international equities are a strong option for investors. While US equities have outperformed their international counterparts eight of the past 10 years, according to data from BlackRock, if the US markets have many years, international stocks offer upside. Historically, international stocks have outperformed 96% of the time US stocks have returned less than 6% in a year, and 100% of the time US stocks have returned less than 4%.
“Despite the slowdown in recent years, international stocks have performed strongly throughout history, outperforming U.S. stocks in nearly half of all time periods over the past 50 years, ” wrote researchers at BlackRock in a recent. report. “With lower returns predicted for US stocks in the coming years, international stocks may outperform first.”
UBS Global Wealth Management CIO Mark Haefele also said in a note on Wednesday that he believes investors should “diversify beyond US and growth stocks.”
“After a strong start to the year, US equities are pricing in a high chance of a soft landing for the US economy, despite tighter credit conditions, reduced corporate income, and relatively high valuations of all risks today,” he wrote. “On the contrary, we like emerging market stocks, which are driven by a weaker dollar, rising commodity prices, strong earnings growth, and stronger China expectations that recovery, along with selected opportunities in Europe.”