The S&P 500 is up 10% year to date. Does it feel like it? While the US stock market is having a strong year and the economy flexes its muscles, long-term investors may be feeling left behind. Why? Domestic stocks are up double digits, but a portfolio of 60% stocks / 40% bonds is only up 5.6%. A more diverse portfolio might only be up 3%. Bonds are flat or slightly down on the year and international stocks are down and being stomped by the strong dollar. Diversification that saved investors from the worst of the financial crisis now weighs on performance.
Why Invest Internationally At All?
Despite the short-term (now intermediate-term, really) underperformance of international stocks, consider:
- The United States makes up about half of the market capitalization of the equities in the MSCI All Country World Index and about a third of the global bond market.
- Access to international stocks and bonds is getting easier and cheaper.
- The global opportunity set is growing as more countries open themselves to foreign investors (China A shares, Saudi Arabia) in both equity and bond markets.
- The strong US Dollar has been a headwind for both developed and emerging market equities.
- Foreign Central Banks are still holding rates incredibly low as they lag behind the US in recovering from the financial crisis.
- Valuations for developed and emerging markets are below their 25-year average while US valuations are higher than their average.
International stocks have underperformed US stocks for the last 7 years on a rolling 3- and 5-year basis. However, the EAFE outperformed the S&P 500 in the 7 years prior to that. The question at that time was why invest in US stocks at all. The same can be asked of value stocks today or even certain sectors of the stock market. Investors who ask these questions are playing a losing game, especially at a time when stocks, sectors, and markets can be moved with a single tweet.
In the short-term, it is frustrating when only one or two assets are going up and the rest of the portfolio is flat or down. Over the long-term, we don’t remember these times, but in the moment, we wonder why we don’t own more of the “good” stuff and less of the “bad” stuff. That’s diversification; we wouldn’t be diversified if all holdings moved in lock step. As prudent long-term investors, we have learned that the good stuff doesn’t stay good forever. Diversification and rebalancing may seem overly simple, but overthinking and market timing are the true threats to wealth. Allocating to international stocks reduced portfolio risk in the past and diversification provides exposure to that opportunity over the long-term without the need to perfectly predict country, region, or currency movements. Brexit, perennial unrest in the Middle East, hot and cold Korean peninsula relations, and sparring over tariffs have been sources of regret for market timers.