S&P 500, Emerging Mkts, EAFE: Which Is Best?

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S&P 500, Emerging Mkts, EAFE: Which Is Best?

In Data today we will continue our discussion of portfolio positioning for 2021 with a comparative look at US large caps versus MSCI EAFE (non-US developed economies) and MSCI Emerging Markets indices.

First up, current valuation math using IBES estimates for the next 12 months of earnings:

  • S&P 500: trades for 20.2x forward earnings
  • MSCI EAFE: 16.5x earnings
  • MSCI Emerging Markets: 14.4x
  • Worth noting: the premium awarded to large cap US stocks is nothing new. The US equity market has traded over non-US equities on a PE basis since 2010, with the gap really taking off in 2012 – 2013.

Next, a look at which phases in a global economic cycle favor EAFE and EM over US stocks, looking at performance from 2006 to the present:


  • Outperformed US stocks in 2006 and 2007 (late cycle) and 2009 (early cycle)
  • Either underperformed or merely kept pace with US stocks from 2010 – 2016 (mid cycle)
  • Outperformed in 2017 (late cycle) but have since lagged US stocks to the present day
  • Worth noting: pull up a long term (2001 – present) chart of EFA, the iShares MSCI EAFE Index ETF, and you’ll see that it is still below levels it reached in 2007. Overweighting EAFE has occasionally been a good trade, but not a sound investment.

MSCI Emerging Markets:

  • Outperformed US stocks in 2006 and 2007 (late cycle) and 2009 (early cycle)
  • Badly underperformed in 2008 but made up ground in 2009
  • Was the single worst performing major cash/bond/stock asset class in 4 different years over the last decade (2011, 2013, 2015 and 2018) and the next-to-worst in 2014.
  • Worth noting: as with EFA, you can use EEM (iShares MSCI EM ETF) to see Emerging Markets’ long run value creation. Simply put, there isn’t any; EEM was right where it is today (about $48/share) as it was in 2007.

What all this tells us: history says you can make decent returns in EAFE and Emerging Markets relative to US stocks either early or late in a global economic cycle. Outside of that, they have not been productive investments since before the 2008 Financial Crisis. Their early/late cyclical bias makes sense, as they rally more than US stocks off the bottom (because they were in more trouble on the way down) and have a late cycle pop when the worldwide economy is running full tilt and their earnings leverage gets one last hurrah.

You’d think that this setup would have been positive for EAFE and EM this year, but both have underperformed US stocks in 2020: S&P 500 +8.3 percent, Emerging Markets +6.8 pct, EAFE actually down -4.7 pct. Even if you had perfectly bottom-ticked EAFE and EM at the March 23rd lows, you would still be underperforming the S&P 500 today. The returns from the lows to now: +59 percent for the S&P 500, +57 percent for Emerging Markets, +42 percent for MSCI EAFE.

Now, past is not always prologue so we should consider EAFE and EM at least somewhat afresh to evaluate their merits going into 2021. Three points on that:

Country weightings:

  • The S&P 500 is obviously 100% US companies but 40% of their revenues come from non-US sources.
  • MSCI EAFE is heavily concentrated in 5 countries: Japan (26 percent), the UK (13 pct), France (11 pct), Switzerland (10 pct) and Germany (9 pct). That totals 69 percent and it’s worth noting these weightings are seriously out of kilter with GDP totals (Japan, $5 tn, Germany 4 tn, Switzerland 700 bn).
  • MSCI Emerging Market is 67 percent weighted to 3 countries: China (43 percent), Taiwan (12 pct) and South Korea (12 pct).

Sector weightings (ranked for each industry from highest to lowest regional weighting):

  • Technology: S&P 500: 28 percent, Emerging Markets: 18 pct, EAFE: 8 pct
  • Financials: Emerging Markets: 17 percent, EAFE: 15 pct, S&P 500: 10 pct
  • Energy, Materials and Industrials combined: EAFE: 25 percent, Emerging Markets: 16 pct, S&P: 13 pct

Single stock concentrations:

  • S&P 500: 23 percent in Big Tech (Apple, Microsoft, Amazon, Google, Facebook)
  • MSCI EAFE: 8% in top five names, a hodgepodge: Nestle, Roche, Novartis, ASML, and AstraZeneca.
  • MSCI Emerging Markets: 27 percent in the top 5 names (i.e. greater concentration than the S&P 500): Alibaba, Tencent (including Naspers), Taiwan Semi, Samsung and Meituan Dianping.

Summing up: Considering these three factors, we conclude:

MSCI EAFE is very hard to recommend.

While it does have by far the highest weighting in cyclicals (Energy, Materials, Industrials), it also has a profound underweight in Technology. If we could forecast +5 percent global GDP growth for 2021 – 2023, MSCI EAFE would likely work really well given the operating leverage in these groups. But we cannot… And, if 2021 proves challenging to the global economy, there not enough Tech to counterbalance this index.

MSCI Emerging Markets is easier to get behind, with a few caveats.

For example, you really have to like at least 2 of these 3 factors: the Chinese economy, EM Financials, and/or Alibaba and Tencent. Still, the first 2 have outsized leverage to a growing global economy in 2021 and BABA/Tencent are strong regional leaders in disruptive technology. All this adds up to a better setup than EAFE.

The S&P 500 is our (narrow) favorite in this trio.

Its concentration in Big Tech is as much feature as bug, given these companies’ reliable profitability and global scope (over 50 percent of Tech revenues are outside the US). The S&P has almost as much cyclical exposure as EM, which will help earnings leverage. Lastly, it has the lowest weighting in Financials, a group we think will be held back by low interest rates well into 2022.