Is Your Portfolio Half Empty?
U.S. stocks have been strong performers in recent years especially when compared to overseas stocks. This outperformance has led many investors to question whether they need any international stock exposure at all? A careful examination suggests that a U.S.-centric investment approach misses out on key portfolio benefits including enhanced diversification and a much greater investment opportunity in leading overseas companies.
The World Is Your Investment Oyster
Aside from strong U.S. stock outperformance, a home country bias by U.S. investors often tilts portfolios heavily in favor of U.S. stocks. This bias refers to the tendency for investors to strongly favor companies from their own countries since they recognize and trust domestic brands more. For example, how many U.S. investors are more familiar with Procter & Gamble than Reckitt Benckiser or Netflix versus iQiyi? In fact, U.S. investors allocate over 70% of their equity investments to U.S. stocks while the U.S. stock market represents about half of the global investable universe.
By overcoming this home bias and focus on recent U.S. outperformance, investors can expand portfolio borders to capture many more investment opportunities from overseas markets. Given that international stocks represent nearly a half of the global investing market (see chart below), investing solely in the U.S. can be like investing with one hand tied behind your back. By broadening investment portfolios globally, an investor can take advantage of investing in leading companies in fast growing regions (think Nestle, Diageo, Roche etc.).
A World Of Opportunities With Stocks
International Stocks Represent 45% Of The Global Stock Market
Source: Thomson Reuters, FactSet, MSCI
A Decade of U.S. Dominance But Will It Last?
An approach of investing solely in the good ol’ U.S. of A. certainly has paid off since 2009 compared to an overseas portfolio as the chart below highlights.
Source: MSCI, Standard & Poor’s, Factset, J.P. Morgan Asset Management
There are a number of factors for this massive divergence in performance over the last decade. First, soon after the financial crisis in 2008, the U.S. Federal Reserve Bank reacted much quicker than overseas central banks which put international markets well behind the U.S. economic recovery. Also, the U.S. market has a much larger weighting in technology stocks which have been huge outperformers in recent years. Lastly, other recent economic simulative measures including broad-based tax cuts have bolstered U.S. equities somewhat.
These factors have attracted huge investment flows into U.S. markets creating historic U.S. versus international stock price performance divergences. The chart below highlights the historic stock price performance differentiation between U.S. and European stocks since 1950 (Europe is by the far the largest region for investing internationally).
Reversion To The Mean?
Investing Playbook: The All Is Not Lost Decade
Market leadership positions between U.S. stocks and international stocks tend to happen slowly and over long periods of time. In fact, in the ten year period ending in 2009, international stocks were the global market leaders by a wide margin as shown in the chart below. Keeping a global approach to equity investing provides investors with a greater chance of participating in the region(s) that are outperforming at any time.
Investing Tides Turning?
The multi-year stretch of U.S. stock dominance has been historic but will it last? As always with investing, it’s impossible to predict when and how much the tide will turn when it comes to the resurgence of international stocks versus U.S. stocks. However, the projections below highlight a more positive forecast for international stocks in the next decade (+8.4%) compared to a more subdued U.S. equity market return profile (+5.1%).
Source: Vanguard, Dimson-Marsh-Staunton Global Returns Dataset, FactSet. As of Sep 30, 2018
“Skate to where the puck is going, not where it has been.” Wayne Gretzky
Former Canadian hockey great Wayne Gretzky could just as well been talking about investing instead of hockey. A key to successful investing is an investor needs to also focus on the future, not just the past. An approach to equity investing that adds high quality international mutual funds, ETFs or stocks can provide greater investment opportunities while transforming a half empty portfolio to one that is brimming with investment opportunities around the world.
David Hone, CFA
1 International Monetary Fund, “Coordinated Portfolios Survey” June 2016