Cash Chronicles was out of the country this week for the first time in over a year. For the last decade, I spend at least a few days somewhere in Latin America every year in addition to my other travels for work, vacation or family. A number of things struck me in my first foreign visit post pandemic, this one being to Mexico.
In my previous post, I discussed the bungling of the opportunity that Europe had to attract American tourists for the summer which they essentially wasted in typical European fashion, plagued by inconsistency, infighting and delays. Love them or hate them, American tourists spend more than any other nationality on vacation in Europe. On arrival in Mexico, it seems that the country’s policy of never totally closing to Americans had paid off. Many had remarked that they canceled plans to go other places and decided on Mexico simply because it was open. The competitive prices due to struggling tourism and the weak peso didn’t hurt either. What struck me as I prodded our taxi driver on the way to our hotel however, was the severity of the lockdown that Mexico had experienced compared to the US. Domestic flights were completely banned as well as travel on the highways. Even in the US at the height of the lockdown, there were still some people (news reporters, emergency workers, politicians etc.) who needed to take domestic flights and many people took to the highways at some point, if anything just to get to the grocery store. Shutting these down completely seems quite extreme but also seems indicative of the severity of much of the lockdowns in Latin America and explains why the pandemic, and the sluggish bounce back, has been so detrimental to the region.
All of this also got me thinking about how markets would perform outside the US in the coming year, especially since so many analysts and market watchers (including myself) had been advocating for international markets and their outperformance since the beginning of this year. Yet the case of Mexico is indicative not just of other emerging markets but even advanced ones as well.
Take the case of Japan. Although the country was able to contain much of the initial spread of the virus through strict social adherence to government protocols, the rollout of the vaccine has been slow and the country saw vaccine deaths peak in February of this year as well as May. This was contributing for calls to delay the Olympic Games again and likely pushed the organizers to ban fans at the games for fear of spreading the virus further. All of this stopping and starting as well as weak vaccination rates puts a serious damper on the economy in trying to bounce back and return to its previous level of output.
US Ascendent Again
All this has contributed to the US markets once again outperforming international ones in the first half of the year. My preference to measure this is through Vanguard ETF’s tracking broad indexes rather than the indexes themselves because they represent an actual investable asset for most people as compared to just the index.
In this way, I measure the US equity market through the Vanguard Total Stock Market ETF (VTI) which is an all cap fund tracking the CRSP US Total Market Index. This index attempts to capture the entire investable universe of stocks in the US market weighted by market cap. As a rule of thumb, I look at it essentially as investing in all the stocks on the NYSE. This is in contrast to the S&P 500 which is only large cap stocks. I use Vanguard because they consistently offer the lowest cost funds. This matters for long term investments because they aren’t relying on zero price sales gimmicks like Fidelity, which offers a zero cost ETF tracking the same market but then depends on cross sale of their other products to investors to keep them afloat. Vanguard consistently delivers low cost funds without pushy sales tactics, which I appreciate.
The other funds I use for comparison are the Vanguard All World Except US ETF (VXUS) and the Vanguard Emerging Markets ETF (VWO). The former seeks to track the FTSE Global All Cap ex US Index and the latter to track the FTSE Emerging Market All Cap China A Inclusion Index.
Both of these funds have underperformed the US in the first half of the year. VTI has returned 14.26% year to date while VXUS has returned 7.76% and VWO 5.75%. The reasons for this have to do with uneven pandemic responses as I mentioned previously but are also linked to differing fiscal and monetary policies of their governments.
Emerging markets were off to a roaring start at the beginning of the year rising as much as 12.77% just through February but they have yet to regain that peak as government interference in China and questions about a general slowdown there have weighed on markets. Yet that isn’t the whole story. Interest rates in the US are a key driver of the weakness of emerging market currencies as well as inflation. Many emerging economies outside of China cut rates last year in the wake of the pandemic but due to the shortage in some goods as well as the bump in long term US rates in February, inflation in many of these countries started to creep up and the central banks were forced to raise rates to stay competitive as investors moved back into the US. Countries like Brazil and Mexico have aggressively raised rates to try and keep their currencies from depreciating and inflation from rising further. The comments from the Fed and the prospect of potentially higher inflation than expected in the US in June and July do not help matters for these central bankers and I expect rates to continue to rise in many emerging economies due to this.
Add to this the limited access to vaccines as well as civil unrest which has reared its head in places like South Africa and Chile and potentially destabilizing elections in places like Peru and you have a recipe for even more capital flight from many emerging economies, seeking the safety and predictable (of overvalued) returns for the moment in the US.
Advanced economy markets have continued to disappoint even though many have access to the vaccine and a rollout plan. Vaccine skepticism is not just a US scourge now but has taken hold in almost all advanced economies. So much so that access to the internet is now positively correlated with vaccine skepticism across countries. A significant minority in these places may never take the vaccine and so may never reach the herd immunity needed to keep the virus at bay, this as well as continued low interest rates with muted inflation has kept the outlook weak for these economies to bounce back as quickly as the US.
The Long View
All of this is enough to seriously make you wonder if it’s even worth investing internationally. The theory underpinning international investing is that economies outside of the home country will offer diversification as well as a pick up in growth slack when the domestic economy or domestic stocks are not as strong. But what about if you live in the US? If you do, the international strategy has been a loser for more than a decade. One way to look at this long term is through the performance of the MSCI US Index divided by the performance of the MSCI World Index. When the figure increases, the US is outperforming the world, when it falls, international shares are outperforming US shares.
From the early 70’s to the late 80’s, going International was a winning strategy. That isn’t to say that returns in the US weren’t good but they were even better in places like Japan and Germany. Yet as these economies matured and caught up with living standards in the US, the US took the reigns back in terms of growth. With the exception of 2002 to 2008 and a few years in the early 90’s, the US has been propelling ahead of the rest of the world.
Recently, this dominance has been further solidified by the profitability of the tech giants like Microsoft, Google and Apple. IT now accounts for over 20% of the industry weighting of the FTSE All cap Global Index and the top holdings all consist of American tech companies, just in a bit smaller proportions to the S&P 500.
What’s interesting about this is that the higher growth story of the last 20 years, China, has not necessarily performed like it’s predecessor high growth markets like Japan or Germany. GDP has grown tremendously in China over the past 20 years and listed companies are coming to the market all the time. China’s share of global GDP is now comparable to the US yet their share of global stocks market cap rivals only that of Japan, while the US remains over 10 times larger.
This could reverse at any time but is that reasonable to expect? No hugely profitable tech giants are emerging from anywhere outside the US to rival Google and Microsoft. The Chinese versions are walled off from the world and partly used to monitor as well as monetize their citizens, although their prospect for growth within China remains huge, their model is not necessarily scalable outside of China.
A commodities rally or an anti-trust groundswell in the US could potentially displace the US tech dominance but for now the US remains the capital markets superpower which investors prefer.
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