Is there upside in global equities, given frothy valuations and an almost unheard-of bull market? We hear this concern a lot. These are historic times: major U.S. stock markets are up over 260% since 2009. The past 50 years have seen only two better rallies. Even so, equities today appear more attractive than bonds, and cash, not just in the U.S. but in international markets too.
Yet as quantitative investment managers, we constantly analyze performance drivers on a risk-adjusted basis. Focusing on risk often helps investors who have portfolio gains they want to protect, should U.S. market conditions change, but also want to participate in future equity opportunities, here and abroad.
I absolutely believe there is room for upside in international equities, even as forecasts for economic growth are positive, but low. No one expects dramatic increases. Investors who want to take profits from soaring U.S. stock holdings can find plenty of opportunity and diversification by investing (selectively) in income-producing stocks on international markets.
Upside potential is particularly strong in high-quality, dividend-paying stocks that can sustain and grow dividend payouts. Not all dividend-paying stocks are alike, so the key is to buy the right companies, in the right markets, without taking on additional and unnecessary risk.
Dividends Can Add Significant Value
Since 1969, the cumulative price return of the European equity market (as measured by the MSCI Europe Index) is up a healthy 1,462%. However, by reinvesting the dividends from those companies instead of taking the cash, the performance would be a powerful 8,593%!
Over the same period, U.K. equity markets (measured by the MSCI UK Index) were up 2,045% on a price return basis; when the dividends were reinvested, the performance was a startling 10,990%.
That is the power of compounding and dollar cost averaging: own companies that can sustain, and grow, dividends. If the market goes down, stockholders receive the same dividend that can be reinvested in lower-priced shares. When the market recovers (as it has, consistently), investors own more shares and participate more fully in the upside.
Since 2000, dividends have contributed 95% of the total return achieved by European equities. In the U.K., dividends were 89% of total return; in Germany, 84%. All this as GDP growth trended downward. Carving out periods of 0-2% real GDP growth back to 1970 shows that dividends still comprised over 50% of U.K. total return, 24% in Germany.