How persistent is regional outperformance?

21 May 2019

Dear investors,

Equity markets recorded significant gains for the fourth consecutive month in a row. The MSCI All countries index now stands 18.3% higher than it did around the turn of the year. The recovery has been most prevalent in the USA (+20.6%), which boasts a large and very well performing Technology sector. Emerging Markets lagged the USA with more than 6% (rising ‘only’ 14.5%). Asia’s most developed economy, Japan, had one of the weaker rebounds (+10.3%) so far.

The United States’ dominance over the last decade has been nothing less than spectacular, with the region outperforming the global equity markets by 38%.  As the USA now roughly makes up 60% of the MSCI All Countries it is a mathematical certainty that when America outperforms the rest of the world underperforms this benchmark. And so, most larger regions did…

Emerging markets, which recovered exceptionally well after the financial crisis, completely lost their headstart over the next years and Europe appears to have underperformed the MSCI ACWI with the regularity of a Swiss watch!

Yet, what goes up generally does come down. If we go back in time even further and plot the trailing 5-year outperformance of the United States compared to Europe it is clear that this outperformance is mean-reverting. In other words, America tends to underperform Europe after prolonged periods of outperformance.

Vector, which is generally under allocated to the USA, has had to cope with a significant headwind from the United States’ dominance, especially over the last 4 quarters.

Vector Navigator recorded a gain of 2.47% in April, bringing its year-to-date gain to 15.54%. Vector Flexible, which has hedged a significant portion of the market risk, evidently wasn’t able to recover as well and ‘only’ gained 5.44% so far. Neither the macro-economic or technical factors from the market timing model have worsened since we increased the hedge earlier this year. Therefore, our market exposure remained virtually unchanged at 37.3%, which ex-post is admittedly more defensive than an investor would’ve liked to be in 2019 – at least so far...

Best regards,

Werner, Thierry and Nils