An Analysis on EAFE Equities

Investors remain wary of equities in the Europe, Australasia and Far East (EAFE) regions and argue over whether the allocation to EAFE equities is still justified, particularly given various downside risks. Research has indicated that investors in equities of those regions are growing impatient. Even though there has been substantial earnings growth, equities generated a negative total return last year. A trend of disappointing performance is akin to the performance seen in the last decade. Keith Knutsson of Integrale Advisors notes that “EAFE equities have a 6% median annual total return over the last 10 years, which is half that of the prior four decades. Even on terms of relative performance median return has lagged the S&P 500 by more than half over the same period.”

Downsides remain; rise of populism across Europe could negatively impact European companies. Similarly, the third of the index’s total revenue that is sourced internationally, which could have detrimental impacts should trade disputes flare up. Additional concerns exist regarding slowing global GDP growth, but many believe that those are already priced in on EAFE earnings growth expectations for 2019. EAFA Earnings growth expectations of 2019 have priced in 50% odds of a US, much higher than most analysts place it at. EAFE equities generally post positive returns and upside surprises much more frequently than large losses when the US economy is still expanding. Also, with exaggerated downsides, investors might be rewarded for investing when valuation are too pessimistic; current levels have seen investors rewarded historically. Current depressed levels of valuation were seen historically (generally) only when equities were in a recession.

 

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