A prominent market strategist, Jurrien Timmer of Fidelity Investments, proposes that developed international equities have finally shed their long-standing image as a 'value trap.' He contends that these markets now present a robust and fundamentally sound alternative to the highly concentrated U.S. stock market, which has been largely propelled by the performance of the 'Magnificent 7' technology giants.
Timmer asserts that the evolution of international markets, particularly in regions like Europe and Japan, has transformed their investment appeal. Previously, the lower valuations in these areas were often seen as justified due to a lack of fundamental drivers for growth. However, this dynamic has reportedly shifted, with foreign corporations demonstrating a significantly improved approach to capital allocation. This change is reflected in the payout ratio for the EAFE index (Europe, Australasia, and the Far East), which now mirrors that of the U.S. at 75%, encompassing both dividends and stock buybacks as a percentage of earnings. Furthermore, the growth rate of these payouts over the past five years has reportedly surpassed that of the U.S. This corporate advancement means investors can access comparable fundamentals at more favorable valuations, with international stocks trading at a price-to-earnings (PE) ratio of approximately 15, markedly lower than the U.S. market's 23.
The argument for diversifying into international markets gains further traction given the historical concentration risk within the U.S. market. The 'Magnificent 7' alone command around 36% of the S&P 500, a level of concentration that Timmer warns could lead to substantial downside risk should the AI sector cool or if valuations become unsustainable. Rather than turning to U.S. small caps for diversification, which face compressed margins, Timmer advocates for a 'barbell' portfolio strategy. This approach involves balancing exposure to high-growth U.S. technology stocks with more attractively valued, shareholder-friendly international equities. By adopting such a strategy, investors can potentially enhance returns while simultaneously mitigating the volatility inherent in a domestic market dominated by a few large players.
Embracing a broader perspective in investment strategy, looking beyond the immediate successes of a concentrated market, allows for more balanced growth and resilience. Diversification into international equities, particularly when supported by strong fundamentals and attractive valuations, not only mitigates risk but also opens doors to untapped potential, fostering a more robust and dynamic investment portfolio for the future.