The Brainwashed Generation Is Finally Losing

Investors have been waiting on this trade for years... And now, it's finally happening.

For a long time, U.S. stocks left foreign markets in the dust. The end of the financial crisis spurred on huge U.S. outperformance. Investors followed those gains – and many gave up on foreign stocks entirely.

But nothing in finance is ever set in stone. Recently, we cited how stocks outside the U.S. absolutely crushed their domestic counterparts.

Specifically, last month, developed markets abroad achieved their largest outperformance in more than three decades. And history shows this rare situation is a good sign for stocks (both here and overseas).

Let me explain...

Foreign Stocks Just Crushed the U.S.

Years of U.S. outperformance have warped investor expectations around the globe.

And this has led to what I call the "brainwashed generation." These are the folks who only began investing after the global financial crisis. U.S. outperformance is all they've ever known. So they assume that's the only way investing works.

For them, owning anything outside the U.S. seems foolish... It would only lower their overall returns.

History disagrees, though. And now, we're seeing the evidence in real time...

The chart below shows the difference in the trailing 15-week returns for the MSCI EAFE Index – which tracks developed markets outside the U.S. – compared with the S&P 500 Index. Take a look...

When the line is below zero, U.S. stocks are outperforming. When it's above zero, foreign stocks in developed markets are outperforming.

You can see that the chart has been mostly negative over the past 15 years. That's because developed markets abroad lagged the U.S. But that trend has reversed over the past few months. And that includes a massive 17-percentage-point outperformance in April... the largest since 1993.

To see what this could mean from here, I looked at every similar setup since the data began in 1970. We've seen 15 similar instances since then. Here's what happened to foreign stocks in the months that followed...

Avoiding foreign stocks was a smart move over the past decade. But you shouldn't stay away today – because you could miss fantastic returns after setups like we just saw.

Similar instances led to 9.4% gains in six months and 19.4% gains over the following year. That's massive outperformance versus buying and holding. Plus, this group was up a year later 93% of the time... So this signal has a great track record.

What's interesting, though, is that this setup doesn't mean the U.S. will perform poorly. Following underperformance streaks like this, U.S. stocks also tend to outperform their usual returns. Take a look...

The difference isn't as impressive as it is for foreign stocks. But six-month returns of 5.4% and one-year returns of 10.8% still beat a typical buy-and-hold strategy for U.S. stocks. And the one-year win rate was an impressive 87%, too.

The point is, foreign stocks are finally outperforming U.S. stocks. The brainwashed generation will assume this is a flash in the pan... But history suggests otherwise.

We can expect stocks outside the U.S. to keep moving higher. And, fortunately, we don't have to give up on the U.S., either. This is an environment where both sets of markets can perform well.

Good investing,

Brett Eversole