The relative outperformance of U.S. stocks over their international counterparts isn’t sustainable in the long run, according to asset manager AQR.
According to AQR’s latest paper, investors who tilted their portfolios toward U.S. stocks, rather than their international peers, over the past 30 years were well rewarded. From May 1994 to April 2023, the MSCI USA Index gained 8 percent annually, while the MSCI ACWI ex USA Index — which includes all developed markets except for the U.S. and 24 emerging markets — returned just 5.3 percent.
But Dan Villalon, principal and global co-head of the portfolio solutions group at AQR, said most investors who chose to overweight U.S. equities in the past “made the right call for the wrong reason.” Overweighting U.S. stocks was more the result of home bias than strong fundamentals, he said.
“Virtually all investors I’ve met with and spoken to recently have a home bias,” Villalon told Institutional Investor. “Everyone feels more comfortable overweighting the country that they happen to be in.”
He added that the primary reason for the outperformance of the U.S. market in the past “is simply that the U.S. got more expensive and people have been willing to pay more for it.” According to the paper, since 1990, the U.S. market has outperformed the MSCI EAFE Index, which includes all developed markets except for the U.S. and Canada, by 4.6 percent per year. But when controlled for changes in valuations, the annual outperformance dropped to only 1.2 percent.
“Sure, 1.2 percent isn’t anything to sneer at, but a statistically insignificant number that is nearly four times smaller than it might seem at first glance isn’t something that merits a massive portfolio bet going forward,” according to the paper.
“[Investors] want to be in the market that’s done the best, and so you end up getting this momentum pattern that’s longer than justified fundamentally,” Villalon said. “For U.S. investors, they think the past couple of decades of returns are evidence that the U.S. is the superior stock market. And there’s this belief in [U.S.] exceptionalism that makes it seem like home bias is the right call going forward.”
The outperformance of the U.S. market won’t persist in the long run, according to the paper. The upward trend may get dented by one or two catalysts, such as a recession in the U.S. or China’s reopening after the pandemic.
“It would take something for countries’ relative valuations to matter again, and nobody knows what that catalyst is going to be,” Villalon said. “But we think it will happen and a diversified investor will reap the benefits.”
