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Underwater Overseas

Adam M. Grossman

IS IT WORTH OWNING international stocks? There’s far from universal agreement. The traditional argument for investing outside the U.S. is straightforward: diversification—since domestic and international stocks don’t move in lockstep, and sometimes diverge significantly.

At the same time, however, international stocks have lagged behind their U.S. counterparts for so many years that it’s been trying the patience of even the most tenacious investors. Domestic stocks have outpaced international stocks in eight of the past 10 years. On average, over that period, the U.S. market has returned 12.3% a year, while the most commonly referenced index of international stocks has delivered 4.6% annually. On a cumulative basis, domestic stocks have more than tripled, gaining a cumulative 219%, while international stocks have gained just 57%.

That’s enough to make any reasonable person question the value of investing outside the U.S. Though the long-term data indicate a benefit to diversifying, we need to be cautious in using the past as a guide to the future. The economist John Maynard Keynes commented that, “In the long run, we are all dead.”

So why, in the face of recent data, would anyone stick with international stocks? Below are five reasons I still recommend international holdings.

1. Performance. Despite Keynes’s quip about the long run, the reality is that you don’t have to go back too far to find periods when international stocks were doing quite well. Most notably, in the years after the dot-com market crash in 2000, international stocks held up much better. If you’d been in retirement at the time and relying on your portfolio for monthly withdrawals, that would have been a great benefit.

One challenge in assessing international stocks—which contributes to the debate around them—is that historical data on markets outside the U.S. is limited. Reliable figures on U.S. shares go back to 1926. But data on international markets go back, in most cases, no more than 50 years. But in the data we have, there’s a clear pattern of U.S. and international stocks taking turns as the better performer. On a chart, their relative results look a bit like a sine wave, oscillating back and forth. International stocks saw periods of outperformance in the mid-1970s, the mid-80s and the mid-90s.

2. Valuation. While valuation metrics such as price-to-earnings (P/E) ratios aren’t entirely predictive of future returns, there’s something of a relationship. When markets are expensive, future returns tend to be lower. Owing to years of relative underperformance, that’s now an argument in favor of international markets.

The P/E of the S&P 500 today is 21, while the comparable figure for the EAFE (Europe, Australasia and Far East) index of developed international markets stands at just 14. Emerging markets are even cheaper, at 12. Some are quick to point out that domestic stocks deserve higher valuations, owing to the preponderance of fast-growing technology companies here. I agree with that. Nonetheless, the valuation gap between U.S. and international stocks has grown. Thus, international markets, on a relative basis, are historically cheap. That may present an opportunity.

3. Exposure to value. What’s been driving the U.S. market higher in recent years? For the most part, it’s the handful of technology stocks now known as the Magnificent Seven: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. Together with one more—Broadcom—technology stocks hold eight of the top 10 slots in the S&P 500, accounting for more than 30% of the total value of the index.

By contrast, what are the largest companies outside the U.S.? Only half are technology companies. The other five of the top 10 international stocks include four pharmaceutical companies and a food manufacturer.

Through one lens, you might view this as a strength of the U.S. market and a point of weakness for markets outside the U.S. But as I noted a few weeks back, growth stocks like the Magnificent Seven don’t always outperform. Value stocks, on the other hand, are distinctly less exciting, but they’ve demonstrated stronger performance than their staid appearance might lead investors to believe. And since value stocks like food and pharmaceutical companies dominate international markets, that gives international stocks a value tilt.

For that reason, adding international stocks to a portfolio can help better balance the mix between growth and value. To be sure, growth stocks like the Magnificent Seven have delivered impressive performance in recent years. But as the standard investment disclaimer states, past performance does not guarantee future results.

4. Defense. As I noted earlier, the top stocks in the S&P 500 account for a disproportionate share of the overall index. The top 10 total more than 35%. When these stocks are doing well, that’s a benefit. But should one of them run into trouble, the top-heavy nature of the U.S. market presents a risk.

By contrast, when you invest outside the U.S., concentration is less of a concern. That’s for two reasons. First, most international markets don’t have any companies on the same enormous scale as the largest firms in the U.S. Second, because most international indexes contain stocks from multiple markets, that helps to limit the weighting of any one company. In a total international markets fund, for example, the top 10 stocks account for just 10% of the total.

5. Currency diversification. International stocks can help diversify a portfolio along another dimension: currency. I wouldn’t recommend buying currencies as a standalone investment, because of their volatility and lack of intrinsic value. But as an added benefit of owning international stocks, currency diversification can provide an additional, potentially helpful source of diversification.

If you want to include international stocks, what’s the right percentage? As I often do, I recommend a “center lane” approach. Today, international markets account for about 40% of the global stock market’s total value. But there’s no rule that says your portfolio must also hold 40%. Personally, I recommend 20%. Why? For starters, if you live in the U.S. and your bills are in dollars, that’s a good reason to hold most of your investments in dollars.

Indeed, there are reasons you might tilt your portfolio toward the U.S. market even if you live outside the U.S. Jack Bogle, the late founder of Vanguard Group, held 100% of his personal portfolio in domestic stocks. Among the reasons he cited: The U.S. has “the most innovative economy, the most productive economy, the most technologically advanced economy and the most diverse economy.”

It’s an important point. While other countries have produced successful companies, the U.S. is unique in the number and size of the companies it’s produced. For that reason, I wouldn’t hesitate to hold the lion’s share of your portfolio in domestic stocks—but there are also good reasons to look beyond our borders.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.

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Bill W.
21 days ago

For past 30 years I have used the rule of 20% of stock portfolio in foreign mutual funds. I re balance in January of each year(in an IRA account) and returns have been very favorable to both US and Foreign holdings. The 3 funds this year have outpaced the DJIA. A word of caution though: doing this in after tax accounts will cause some tax reporting and paying challenges.

AnthonyClan
23 days ago

Not mentioned, there is always a higher expense/fee cost related to international stocks. “Currency diversification” cuts both ways.

Martin McCue
23 days ago

The one thing that Bogle didn’t mention, but that is a critical and keystone strength for American stocks, is that the US has the best system of laws in the world, and the rule of law (applied through our securities laws and regulations, and the state and federal courts and administrative agencies) is what gives investors confidence that the information they get about public companies is going to be honest and accurate, and that an investor can expect to be treated fairly in buying and selling his or her investments. This strength is taken for granted but cannot be overstated. In comparison, how much do you trust the information you get about public companies in China? Or India? Or South America generally?

Jonathan Clements
Admin
23 days ago
Reply to  Martin McCue

Everything you say is true. But here’s a question we should all ponder: Are the advantages cited already reflected in U.S. stocks — and the reason foreign shares sport lower valuations and hence have higher expected returns?

jerry pinkard
27 days ago

I am a long time investor. I used to invest 20% or more in international funds. That has dwindled to only 6% in a FTSE Developed Market fund and I am tempted to sell that due to its underperformance.

Bogle’s argument for no international was that most large US companies are really global and do lots of business internationally. So why invest in international companies too?

I learned years ago to avoid emerging markets. These funds and etfs are boom and bust. Their volatility is mind boggling. Also, the oversight and accounting in many of these countries is very weak.

bbbobbins
28 days ago

Hmm. I think just buying a US tracker is not really diversifying compared to buying a whole world view. Maybe you have to be outside the US to see it but sometimes US valuations look crazy.

I bought a big slug of FTSE 100 index a few years back on the day Apple market cap surpassed the whole FTSE100 as it just didn’t seem rational that a single consumer tech player could long term be more valuable than 100 multinational multi industrials from oil majors, industrial products, pharmacy, defence etc.

macropundit
28 days ago

T top stocks in the S&P 500 have always resented a disproportionate share of the overall market. It has always been this way. In fact if you go back before the 80’s the concentration, despite the oft repeated mantra, it was higher. AT&T itself was 13% of the index in the 30s. IBM was about where Apple was until recently –if not still– at 7%. And GM and AT&T in the 50s? That was some ridiculous percent of the market. Earnings drive valuation, the same as it ever was.

Also see the piece “200 Years of Market Concentration” by Bryan Taylor, Chief Economist at Global Financial Data.

Ben Rodriguez
29 days ago

That’s enough to make any reasonable person question the value of investing outside the U.S.” I resemble that remark. Very timely and thoughtful article.

Although my Int’l investments have been laggards I continue to invest (coincidently?) targeting around 20% of total portfolio. Another benefit to Int’l in addition to the value tilt is a higher dividend yield. I sure hope I don’t regret these investments anymore than I do, but we just don’t know.

Also, one minor correction. At the end of his life I heard Bogle say his portfolio was 50% stocks and 50% bonds. 100% of his stock portfolio was in domestic, but he wasn’t 100% equities.

William Perry
29 days ago

John Bogle in his book Common Sense on Mutual Funds 10th Edition has a entire chapter titled On Global Investing.

In that chapter Mr. Bogle wrote –

Overseas investments – holdings in the corporations of other nations – are not essential, nor even necessary, to a well-diversified portfolio. For investors who disagree – and there are some valid reasons for global investing – I would recommend limiting international investments to a maximum of 20 percent of a global equity portfolio.

There appears to be substantial agreement in the conclusions of Bogle and Grossman as to their 20% recommendation of the maximum percentage of international holdings in a global portfolio for American investors.

David Powell
29 days ago
Reply to  William Perry

I do not favor a 20% international allocation target, but that’s just what works for how I invest. A 20% target may work wonderfully for lots of people.

Among the best advice I’ve ever read was this, from Morgan Housel: “…few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are.”

David Powell
29 days ago

The original Dimson, Marsh, Staunton dataset, from Triumph of the Optimists, has real and nominal stock return and risk premium data for the 23 largest global markets starting from 1900. It’s a small slice of the global community by country but accounts for most world stock market capitalization. DMS’s newer dataset, which supports their excellent annual Global Investment Yearbook, has added data for another 67 countries, though over shorter time periods. You can read the free summary edition of their current Yearbook here.

Correlation rates vary over time, of course, but DMS wrote back in 2000 they found portfolio volatility shrank, for a dollar-based investor, for each additional country’s cap-weighted stock index added to a portfolio. After including indexes for 16 countries, further volatility reductions were small.

The US stock market’s share of total world stock market cap is ~60% today but has averaged ~50% since 1970; it started at ~15% in 1900.

B Carr
29 days ago

Mr Bogle also proffered that since many/most US companies trading on the exchanges are multinational in operation, there is enough international “exposure” through them.

sjoag
29 days ago

I agree with the points made – and keep roughly 25% of my stock exposure in VXUS and 75% in VTI That is still an overweight of US stocks, but I do expect that the US outperformance of the last two decades will mean revert at some point in the next decade. Until then, I’ll enjoy the ride US stocks have been giving.

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