With the recent outperformance of U.S. large growth stocks, in the technology and communications sectors in particular, does it make sense to invest internationally?
“Investors will likely be surprised to learn that U.S. stocks have only been the top-performing asset class for three out of the last 10 years, and in 2023 foreign stocks were the second-best-performing asset class,” says Alex Michalka, vice president of investment research at Wealthfront.
“This kind of variation is exactly why it’s beneficial to own investments from a broad range of asset classes,” he says, adding that investors who hold a greater number of asset classes are more likely to own the market’s high performers.
What Is Home-Country Bias?
U.S. investors typically get plenty of news about domestic indexes like the S&P 500, Nasdaq Composite and Dow Jones Industrial Average.
There are good reasons why U.S. markets are so dominant. According to the Securities Industry and Financial Markets Association, U.S. equity markets accounted for 44.9% of the $109 trillion global equity market cap in 2023.
In addition, investors throughout the developed world have “home-country bias,” a tendency to favor domestic securities over foreign ones. It stems from familiarity with domestic stocks and companies, as well as a perception that stocks from one’s home country have lower risk.
For those reasons, it’s not difficult to understand why many U.S. investors pay scant attention to international indexes.
Advantages of International Diversification
International stocks offer U.S. investors diversification, reducing reliance on domestic markets and potentially enhancing returns.
Non-U.S. stocks can provide exposure to global economic growth, mitigate geopolitical risks and tap into industries not heavily represented domestically.
According to a 2022 blog post from asset manager TIAA, “Why International Stocks Still Make Sense,” U.S. multinational companies tend to represent certain parts of global industry and not others. “For example, by only owning U.S. multinationals, investors will likely end up holding a lot of technology and health care firms,” TIAA stated. “However, they’d be underrepresented in other important parts of the global economy, such as basic materials.”
Financial Planning Approach to International Stocks
Planners who advise assembling a diversified portfolio typically suggest allocating to non-U.S. stocks and bonds. That allocation can be split among developed and emerging markets, depending on an individual investor’s goals and risk tolerance.
“In general, I recommend clients hold 20% of their assets in international investments,” says Jay Zigmont, founder and CEO of Childfree Wealth in Mount Juliet, Tennessee.
“While there are a variety of good reasons to diversify internationally, I usually explain it as a way to protect against craziness in the U.S.,” he says. “With the current political environment, it doesn’t matter which side you are on, we can all agree that hedging against U.S. craziness makes sense.”
International Stock Returns Under the Microscope
In general, recent underperformance of foreign equities has been due to the strength of U.S. companies, such as the so-called Magnificent Seven stocks that led the market in 2023: Alphabet Inc. (ticker: GOOG, GOOGL), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Meta Platforms Inc. (META), Microsoft Corp. (MSFT), Nvidia Corp. (NVDA) and Tesla Inc. (TSLA).
While some of those, most notably Tesla and Apple, are off previous highs, stocks like Nvidia, Microsoft, Google, Amazon and Meta continue to ride high on the strength of artificial intelligence technologies.
Developed-country international equity underperformance is largely attributable to the S&P 500 trouncing international stocks in the period of time from 2008 through 2023, says Jeff Krumpelman, chief investment strategist and head of equities at Mariner Wealth Advisors in Cincinnati, Ohio.
“Despite getting trounced in this latter chapter, performance over the longer term from 1970 through 2023 is relatively close,” he says, adding that the S&P 500 beat the MSCI Europe, Australasia and the Far East Index by less than a percentage point during that time period.
“Periods of international underperformance are most prominent and tend to be tethered to weakness in the dollar rather than tied primarily to weak local country returns,” Krumpelman adds.
Arguments Against Global Diversification
While most planners and portfolio managers see the benefits of international diversification, others say it’s not necessary.
“Buying international stocks is very overrated for diversification because approximately 30% of the S&P 500 companies’ revenue is international, and it’s higher for the mega-cap stocks,” says Drayton D’Silva, CEO and chief investment officer at Tower Hills Capital in New York.
As a result, D’Silva says, an investor in the S&P 500 already has significant economic exposure to global markets. For example, he cites international revenue totals in 2023 for several of the top-performing S&P 500 components:
— Apple: 58%
— Microsoft: 50%
— Meta Platforms: 61%
— Nvidia: 56%
— Eli Lilly & Co. (LLY): 36%
“The correlation of U.S. and international stock markets is increasing because global economies and capital markets have been becoming more integrated, further reducing the diversification benefits,” D’Silva says.
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Are International Stocks a Good Investment Now? originally appeared on usnews.com
Update 04/11/24: This story was previously published at an earlier date and has been updated with new information.
