Thread by @sonusvarghese

Been an amazing decade for US stocks, especially compared to International (USD terms)

2010 - 2019 (Nov)

US (MSCI): 246%
World Ex US (MSCI): 63%

Breaking down International -

Developed (MSCI EAFE): 73%
Euro Zone (MSCI EMU): 56%

Emerging Markets (MSCI EM): 38%

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This is a massive reversal from what we saw in the prior decade. Starting after the 2000-2002 bear market,

from 2003 - 2009 -

US: 48%
World Ex US: 133%

Developed: 105%
Euro Zone: 124%
Emerging Markets: 311%

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So should we expect another reversal over the next decade?

For that, we should dig into what's driving these differential returns.

Critical piece is the US dollar - depreciating (2000s) or appreciating (2010s).

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Here's the USD vs excess returns for MSCI World ex US over MSCI USA

I used annual returns (2003-2009), with currency return backed out from Local vs USD returns annually

45% of variation in annual excess returns can be explained by the currency

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The fit is even better if you just consider excess returns for the Euro Zone

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And even more so for Emerging Markets!

Currency explains 64% of variation in excess annual returns

@lhamtil discussed this in his piece on FT Alphaville

ftalphaville.ft.com/2019/11/05/157…

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But what drives currency?

A good predictor of USD is the relative growth differential between US and rest of the world.

Here a chart of differential z-scores between US and World GDP growth (calculated annually, with z-scores over prior 10-year data) versus the USD index

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USD is a risk factor, and especially so for EM - via the financial and credit channel

And looking ahead, where's the USD going?

In the near term, we may see USD fall as a cyclical recovery picks up around the world and World-ex US surprises to the upside.

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But long term, hard to see how this is sustained.

2000s were unique as newly liberalized EM economies saw lot of investment & capital flows to build export capacity that serviced DMs

However, the past decade has seen slower growth in DMs & EMs appear to have hit a ceiling

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@nosunkcosts has tweeted a lot about this. How EM equities work best when there are large growth surprises vs the US

We're done with that now. The EM growth shock passed in the 2000s.

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Even in the Euro zone, growth differential with the US has been a driver of the currency

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The EU has become increasingly reliant on exports and the export cycle has become more dependent on China in recent years.

Which is not great, since China is slowing and looking inward i.e. lower imports

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So, the next decade may not see a reversion to the mean, with foreign stocks outperforming US.

Unless we see a few surprises, including fiscal stimulus in the EU and a turn to stimulating domestic demand in the World ex US (which will be hard for EMs).

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