The Best ETF to Buy After the S&P 500’s Record Close | The Motley Fool

Got the itch to dive headfirst back into the stock market? It would be understandable if you did. After all, the S&P 500 (^GSPC -0.33%) recently reached yet another record high, prompting fears of missing out on any further gains. Even something as simple as a new or bigger stake in the SPDR S&P 500 ETF Trust (SPY -0.33%) would be an easy way to get back in (or get in deeper).

Before succumbing to temptation, though, you might want to consider a safer — and arguably smarter — alternative. Rather than adding more exposure to the United States’ economy, why not take on more international exposure? Not only are foreign stocks currently trading at much cheaper valuations than their U.S. counterparts right now, but they’re also performing better.

And the iShares Core MSCI EAFE ETF (IEFA -0.98%) would be all you need to do it.

The last 15 years aren’t the permanent norm

It’s an age-old investing question: Do you really need international stocks when shares of (predominantly) U.S. companies have a history of solid, reliable performance?

The answer is still the same, though. Yes, you do. And it’s for the same chief reason that’s always held: U.S. stocks don’t actually have the corner on performance. Between 2002 and 2009, for instance, foreign stocks beat the S&P 500. Blame a relatively weak U.S. dollar, mostly.

And following 15 years of dollar-driven leadership from U.S stocks, a weak dollar may finally be the basis for another period of overdue outperformance from foreign tickers.

After soaring during and because of the COVID-19 pandemic, the U.S. Dollar Index hasn’t made any net gains. Indeed, after peaking early this year, it’s fallen back to multiyear lows as the United States economy encounters some self-induced trade turbulence while at the same time is finally coming to a reckoning with all the dollars printed during the coronavirus contagion. In this vein, know that while the U.S. stock market has performed incredibly well since April’s low, most other markets have performed even better; the rest of the world seems to be moving on with or without the United States as a key trade partner.

That’s a big takeaway from a recent podcast interview Morningstar Wealth conducted with its Chief Investment Officer for the Americas, Philip Straehl, anyway. “We do think that some of the forces that have pushed US stocks higher, we’re going to see somewhat of a reversal there, and we’re going to see a recovery in non-U.S. stocks because some of these temporary factors that have impacted the underperformance will reverse on the other side,” Straehl said.

Analysts with brokerage firm Charles Schwab agree, by the way. Jeffrey Kleintop and Michelle Gibley noted in a recent news article, “[I]f international outperformance continues, the three-year mark for outperformance of the MSCI EMU Index relative to the S&P 500 Index would be reached this October and could prompt even more flows into international stocks.” The duo concluded, “It’s likely not too late to add international stocks to portfolios that remain underweight strategic targets, since these relative performance trends can last for years.”

The valuation argument alone is enough

Perhaps the chief argument for owning iShares Core MSCI EAFE (Europe, Australasia, and Far East) ETF over the SPDR S&P 500 ETF Trust, however, is a far simpler one — it’s just cheaper.

As of the latest look, the S&P 500 is priced at 24.5 times its trailing earnings and 23.6 times its forward-looking earnings projections. That’s sky-high by historical standards, as is Schwab’s calculation of the S&P 500’s 10-year average price-to-earnings ratio of nearly 18.4. That’s in stark contrast with most foreign stocks. Schwab says the MSCI EAFE’s 10-year average P/E stands at only 14.2, while the exchange-traded fund’s trailing-12-month price-to-earnings ratio is only slightly higher at 16.7.

Do you need to be willing to pay a premium for quality? Maybe some of the time. When the “premium” premise stops working though, it can stop working in a big way. That’s when you’ll wish you were at least a little more worried about valuation, and a little less worried about latching onto well-loved-but-pricey stocks.

Or think about it like this: All of the analysts mentioned above pointed out the valuation disparity between U.S. stocks and foreign ones. As Schwab’s Kleintop and Gibley explain, “International stocks are currently valued close to their historical averages, whereas U.S. stocks are currently over-valued relative to history, implying greater price appreciation potential for non-U.S. stocks.” Or as Morningstar’s Straehl put it, “We do think both developed and emerging-market countries are more attractively valued, and we think that that will benefit performance over the next 10 years.”

There’s not a lot of reading between the lines to be done here.

Just some much-needed diversification

This isn’t necessarily a call to shed any position in the SPDR S&P 500 ETF Trust you may already hold, or to dump any individual U.S. stocks you may own. You’ll be fine in the long run. Indeed, the strongest and highest caliber of stocks can perform even with a rich valuation … usually. There’s nothing inherently wrong with sticking with a broad-based investment in the United States via an S&P 500 index fund in the meantime, either.

Given the current circumstances and backdrop though, adding some international exposure that you might not normally take on makes strategic sense here. If nothing else, stepping into a stake in IEFA just shields some of your portfolio from all of the economic or political drama plaguing the United States right now.

By the way, some of the iShares Core MSCI EAFE ETF’s top holdings are Germany’s SAP, technology outfit ASML, confectioner Nestlé, and Swiss drugmaker Novartis, just to name a few. You’d be buying into a group of quality foreign names, but names that would otherwise be difficult to individually buy and monitor on your own.