February gave strong returns to all three equity funds. The C Fund went up 3.2% for the month, the S Fund went up nearly 5%, and the I Fund went up just over 2.5%. The G Fund gave returns of 0.2%, and the F Fund declined by 0.06%.
For the first two full months of 2019, the results are even better. The C Fund went up almost 11.5% during January and February, while the S Fund went up nearly 17.2%. The I Fund lagged somewhat but still posted a respectable 9.3% gain as well.
Despite this strong performance, the S&P 500, which the C Fund tracks, still hasn’t recovered its highs from 2018:
The S&P 500 index erased most of its recent losses due to this unusually strong rally, but still has over 100 points to go if is to reclaim the all-time high set in late 2018.
From March 2018 to September 2018, U.S. stocks and foreign stocks diverged significantly, with U.S. stocks continuing to climb while foreign stocks sold off. At the peak of divergence, it reached a point where U.S. stocks had outperformed international stocks by over 12% within those six months.
However, since September, the S&P 500 (C Fund) and the MSCI EAFE (I Fund) have achieved rather tight correlation once again:
It’s challenging to know which funds will do the best over the next economic cycle. As I showed in my recent article (Is the I Fund a Bargain Now, After So Much Underperformance?), some analysts expect international stocks to outperform U.S. stocks over the next decade, because they are starting from much lower valuations at this point.
On the darker side, many foreign developed countries are showing signs of an upcoming recession or economic slowdown earlier than the United States. The economy with the biggest GDP in Europe is Germany, and their manufacturing purchasing manager’s index (PMI) dropped off sharply in 2018:
Germany Manufacturing Purchasing Manager’s Index
For the PMI, anything over 50 is considered expansionary and under 50 is considered a contraction. Germany’s PMI is now at a six-year low and is in contraction.
On the other hand, the German stock market is already pricing in a lot of downside risk from the German economy. According to MSCI, Germany’s stock market has an average price-to-earnings ratio of 13 and an average price-to-book ratio of 1.5. The average dividend yield among German stocks is a robust 3.3%. In contrast, the United States market has an average price-to-earnings ratio of nearly 20, a price-to-book ratio of over 3.2, and a dividend yield of barely 2%.
Italy’s PMI has also fallen into a contraction, and their PMI is currently the lowest it has been since at least 2012.
France and the UK also saw sharp declines in their PMI figures for 2018, but they are at just over 50 at the current time; not yet in a contraction. And like Germany, their markets are inexpensive based on most valuation metrics.
Japan, the largest component of the I Fund, recently saw its PMI dip under 50 for the first time in almost 3 years. This is arguably less notable than the other examples because Japan frequently hovers around 50 for its PMI, regularly going mildly above or below that point.