Earlier this week, the International Monetary Fund released its most recent World Economic Outlook, in which they downgraded global output by -0.1% to 3.2%, primarily driven by the potential for trade tensions to weigh on business investment and sentiment. While the greatest negative changes occurred in the developing world, advanced economies saw a 0.1% increase to 1.9%, thanks to an increase to U.S. growth to 2.6% from 2.3% as the world’s largest economy displayed unexpected strength in the first quarter.
With U.S. equity markets marching toward their highest relative valuation compared to international equities, we remain more favorable on the U.S. thanks to its profitability advantages amid the ongoing slowdown in economic activity that sees risks skewed to the downside
What We’ve Seen
- U.S. firms have outperformed international companies by a whopping 7.62% year-to-date and 8.61% over the last twelve months. Annualized returns over the last 10 years tell a similar story, with U.S. stocks delivering a 14.27% return, good for 7.84% of outperformance.
- While it can be tempting to point to these extreme levels of relative returns leading to an imminent reversal, one should turn to valuations to help gauge whether one market is stretched. In this case, valuations of U.S. companies relative to international companies are indeed trending toward the all-time highs they hit in August 2018 – we believe that this remains justified
RELATIVE VALUATIONS ARE CREEPING BACK TO ALL-TIME HIGHS
Money in Motion
Even with two months of aggregate flows in the red, investors added $44.56 billion to U.S. Equity ETFs and $21.86 billion to International Equity ETFs over the last twelve months with flows improving in June and July after faltering in May.
- The $22.69 billion relative advantage for U.S. ETFs is consistent with the recent performance trends that have heavily favored U.S. markets. This is not to say that International ETFs have not seen inflows, but that demand for U.S. equity exposure has far outweighed that for international.
- Year-to-date, the U.S. remains in the flow lead by $7.98 billion. This is even more remarkable considering the outflows of $13.87 billion in January and $16.14 billion in May that were led by trading product activity.
ETF FLOWS CONTINUE TO FAVOR THE U.S.
Source: Bloomberg Finance, L.P., as of August 1, 2018 to July 23, 2019. Data represents the net flows of U.S.-listed U.S. Equity ETFs and International Equity ETFs, specifically targeting exposure to U.S. and international markets, respectively. For example, when the blue or orange bars are positive, net flows were positive. On the other hand, when the blue or orange bars are negative, net flows were negative.
A structural challenge in today’s environment that faces shares of international companies is their lack of efficiency compared to U.S. firms as measured by Return on Equity (ROE).
- Historically, the ROE for international companies is below that of the U.S. However, a persistent gap between the two series persists and currently stands at a difference of 7.25% highlighting how much more profitable U.S. companies are comparatively.
- The difference in ROE is driven primarily by sectors, which sees the U.S. having higher weights to sectors with structural higher ROE, especially Information Technology. However, the U.S. has higher ROE than international in eight of the eleven sectors indicating that this is more than a Tech story.
THE U.S. ENJOYS MUCH HIGHER ROE THAN DOES INTERNATIONAL
- With 150% exposure to the Russell 1000 Index and -50% exposure to the FTSE All-World ex US Index, the Direxion FTSE Russell US Over International ETF [RWUI] allows investors to increase their weight to U.S. equities relative to their International peers in one ETF.
- The Direxion FTSE Russell International Over US ETF [RWIU] is structured in the opposite way with an overweight to International firms and underweight to U.S. companies allowing an investor to get amplified exposure to undervalued International companies.
- Russell 1000® Index: The Russell 1000 Index consists of the largest 1,000 companies in the Russell 3000 Index, which is made up of 3,000 of the largest U.S. companies.
- FTSE All-World ex US Index: The FTSE All-World Excluding United States Index is a free float market capitalization weighted index. FTSE All-World Indices include constituents of the Large and Mid-capitalization universe for Developed and Emerging Market segments.
Direxion Relative Weight ETF Risks – Investing involves risk including possible loss of principal. The Funds’ investments in derivatives may pose risks in addition to, and greater than, those associated with directly investing in or shorting securities or other investments. Investing in, and/or having exposure to, foreign instruments may involve greater risk than investing domestic instruments. The Funds’ returns and net assets may be affected largely by fluctuations in currency exchange rates, political, diplomatic or economic conditions and the regulatory requirements of foreign countries which typically are not as strict as in the U.S. There is no guarantee that the returns on the Funds’ long or short positions will produce high, or even positive returns and a Fund could lose money if either or both of the Fund’s long and short positions produce negative returns. Please see the summary and full prospectuses for a more complete description of these and other risks of the Funds.
Distributor: Foreside Fund Services, LLC