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FRENCH HISTORIAN Alexis de Tocqueville toured the U.S. in the 1830s and chronicled his observations in a book titled Democracy in America. What mainly impressed him was Americans’ focus on trade and commerce.
They have a “purely practical” mindset, he wrote, and concluded that “the position of the American is quite exceptional.” In the years since, others have picked up on this concept of “American exceptionalism.”
Despite recent political and economic crosscurrents, the gap between the U.S. economy and its peers has only widened, especially over the past dozen years. Between 1990 and 2012, according to an analysis by author Larry Swedroe, corporate earnings in the U.S. grew no faster than in other countries.
But since 2012, American companies’ profits have multiplied while—in aggregate—international companies’ earnings have stagnated. As a result, markets in the U.S. have far outpaced their international peers. This has made investing outside the U.S. feel like a losing proposition for quite some time.
On the surface, this seems easy to explain. In the U.S., entrepreneurship is key to our DNA, and our regulatory regime makes it easy to get a business started. Hewlett and Packard got their start in Packard’s garage. Gates and Zuckerberg founded trillion-dollar companies in their dorm rooms. Jensen Huang launched Nvidia from a booth at Denny’s.
By contrast, on the other side of the Atlantic, regulations make it harder to build a business. There aren’t any companies in Europe comparable to the “Magnificent Seven” technology firms in the U.S., and there are just a handful elsewhere in the world. In the European Union, working hours are strictly limited. In 2023, when the French government tried to raise the official retirement age from 62 to 64, more than a million people took to the streets to protest.
Through this lens, the U.S. economy’s outperformance seems to make sense. But this story may be oversimplified. Indeed, since the beginning of this year, markets in the U.S. have begun to falter. Domestic stocks are mostly in negative territory, while stocks outside the U.S. have delivered solid positive performance. This has people taking a second look at the question of American exceptionalism. Specifically, the question investors are asking is: To what degree should a portfolio be diversified internationally?
This isn’t such an easy question. Ask the Vanguard Group to construct a portfolio, and it’ll be split roughly 60-40 between domestic and international stocks. Vanguard’s view is that there’s no reason to favor any one country or region of the world over another, and thus investors’ portfolios should simply reflect the relative weightings of world markets. But Vanguard’s founder, the late Jack Bogle, took an entirely different view. He didn’t hesitate to tell people that his personal portfolio was 100% domestic. U.S. stocks, he felt, were entirely sufficient.
There is, in short, no consensus on this question. Still, to gain clarity, we can consult the data.
In a 2023 paper titled “Still Not Crazy After All These Years,” hedge fund manager Cliff Asness examined the outperformance of domestic stocks, performing what’s known as attribution analysis to uncover the sources of that performance. His conclusion: The lion’s share of domestic stocks’ impressive gains over the prior 15 years wasn’t due to earnings growth. It wasn’t, in other words, due to the exceptionalism of American companies. Instead, those companies’ stocks had, for the most part, just become more expensive.
Even though U.S. stocks have given up some of their lead this year, that valuation gap is still very significant. Using the price-to-earnings (P/E) ratio as a measure, domestic stocks today are still 40% more expensive than their peers in developed markets outside the U.S.
Boosters of a domestic-only approach are quick to reply that American stocks deserve higher valuations. There is no “Magnificent Seven” anywhere outside the U.S., they argue, and these companies’ scale and impressive growth warrant higher valuations. But that argument quickly falls apart. As Asness points out, domestic and international stocks traded at comparable valuations as recently as 2007. The valuation gap is a new phenomenon.
According to the Swedroe analysis referenced above, another factor has contributed to domestic stocks’ outperformance: Between 2008 and 2024, the U.S. dollar appreciated nearly 20% against international currencies. This depressed the value of international stocks for U.S. investors, thus further boosting the relative performance of domestic stocks. There is, however, no guarantee that this trend will continue—and, indeed, it could reverse.
To be sure, there are unique aspects to the U.S. economy, and de Tocqueville’s observations have validity. But a quantitative analysis suggests that the extreme U.S. outperformance we’ve seen over the past dozen years may not continue indefinitely. Despite some erosion this year, domestic stocks still carry elevated valuations compared to international markets, and the U.S. dollar is still expensive. This is worth paying attention to, because ultimately valuations do matter. Investments that are expensive usually don’t offer the same prospective returns. That’s certainly what history suggests.
While it may be hard to remember, there have been multi-year periods when international stocks have outperformed the U.S. market. In fact, a chart of domestic vs. international stocks looks a little like a sine wave, with performance alternating over time. For that reason, I continue to recommend an allocation to international stocks. How much? I suggest something in the neighborhood of 20%. According to the data, that’s enough to deliver a diversification benefit, but not so much that it introduces significant currency risk.
A final note: You might notice that I haven’t mentioned the proximate cause of the valuation shifts we’ve seen this year—the new administration’s tariff policies. I’m not focusing on this specifically because I see it as just one example of how markets can shift unexpectedly. In choosing an international allocation—or any other aspect of your portfolio—I recommend taking the long view. My advice: Choose a structure that you think will make sense regardless of who is in the White House or where the economy happens to stand at any given time.
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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You mentioned 20% allocation to international stocks. Is that 20% of one’s equity portion or of entire portfolio? Good writing!
I read it as 20% of equities.
Yes, 20% of equities. Sorry for not being clearer!
Great information Adam and we appreciate all of your discussion. I have chosen to stick with what I call my Buffett rule, and invest all in the USA and most all in the S&P 500 85% and 15% in cash, that is worldly enough for me.
Ah yes, to own or not to own, that is the question.
Foreign stocks occupy about 12% of my [equities]. But some have done well. For example, the best performing individual stock in my portfolio is a European company which shows a gain of 538% since 2008. It is 29% off of the all-time high and as good as [538%] sounds, these returns are dwarfed by ASML which is a part of a fund I own. Including that decline my YTD total return is negative 1.59%. The gains for each year since 2018 when I began drawing from my retirement accounts have been positive. However, because of the allocation and that annual drain I have not able to achieve the gains of the S&P 500. That’s the price for diversification. Not that I care; I like the dividends.
Foreign stocks are like cash. They can provide a drag on a portfolio. I manage this by monitoring my total returns and volatility. One criterion is meeting my “sleep number”.
“It wasn’t….due to the exceptionalism of American companies. Instead, those companies’ stocks had, for the most part, just become more expensive.” I’ve held that opinion, ergo my interest in foreign stocks.
In aggregate, foreign markets haven’t been all bad. I’ve read that, since 2015 the S&P returned 16.9% annualized per year, while the Brazil and India stock exchanges both returned 15.9%. New Zealand and Viet Nam returned more than 10% annually.
The challenge of international stocks is that, as noted “international companies’ earnings have stagnated. As a result, markets in the U.S. have far outpaced their international peers. “ I think that is generally true for Europe.
If Europe’s regulatory climate and the level of governmental control were different, I’d be more likely to expand my investments there. But IMHO, doing business there is like driving a car with the parking brake on. And they extend that parking brake to American companies doing business there – levying fines under their technology-protective rules that are so large that I’m surprised those American companies still do business there.
It is impressive that European stocks have done so well in the past year or so, but IMHO, that is probably not the main reason to take a new look at those stocks. To me, a better reason is grounded in some of the new messaging from the EU after the recent political explosions over tariffs and protectionism. A number of senior EU representatives actually admitted that they need to loosen up their regulations to let their businesses compete better, and to remove barriers that make it hard to operate freely. However, my response is still, as the guy from Missouri says: “Show me”. If their actions actually follow their words (“acta non verba”), I think they will finally get to a structural foundation that can deliver more than their recent streak of success. Otherwise, that streak won’t last.
An additional parking brake has been applied by the US to foreign products. Regardless whether tariffs stick, in the last two months we have had major delays in receiving specialized scientific instruments from overseas. I can’t deny that the manuals for these have pages and pages of warnings and regulatory hoops that had to be jumped through for the European markets, many of which are laughable, whereas some really do make them safer– and this will be important going forward as US regulations are essentially gone.
What I’m referring to is so many customs agents have been fired that the instruments arrived at US airports and didn’t clear. We’ve gotten used to air freight from anywhere going point to point in as little as three days, but since Feb we’ve had unpredictable delivey, the longest wait being six weeks including not knowing where the box was once it entered the customs process. We had engineers fly in this week to install something that was supposed to be delivered a week earlier from Germany, but they didn’t have the equipment for the first two days because it was tied up in customs. Maybe this process will get sorted out, but at least for now it has resulted in a bottleneck. Just-in-time delivery for international shipments may be a thing of the past.
And here’s another potential brake: deportations. Whether it’s a specialist surgeon or an engineer or the guy you pay to drive you to the airport, when they are fired by a meddling gov’t, this is bad for business. It hobbles the entire process. I don’t want to get into the immigration debate here, but all these people were here as part of a legal process. Sudden erasure of expected procedures is bad for business.
Always a voice of reason, Adam, influencing others to adopt a practical or balanced perspective and act sensibly and logically.
Thank you.
I think the gap in American exceptionalism is getting more narrow if it even exists anymore. I’m not sure working more than 40 hours a week defines exceptionalism either, as the previous writer mentioned, and I’m pretty sure foreigners are goal driven as well. The market will shift and foreign stocks will lead again, just as they have in the past. I think the concept of American exceptionalism is another form of nationalism, and many others feel the same way about their countries. As a well know foreign policy analyst store at foreign policy.com wrote: ‘The Myth of American ExceptionalismThe idea that the United States is uniquely virtuous may be comforting to Americans. Too bad it’s not true.’
This comment reminded me of my father: “My advice: Choose a structure that you think will make sense regardless of who is in the White House or where the economy happens to stand at any given time.”
My father said, “Teach it to them in black and white, and let them shade it in themselves.”
I always enjoy the discussions on domestic/international allocation. It appears everyone here has “shaded it in” themselves.
I especially like your final sentence, which is consistent with Bogle’s advice to stay the course. I leave it to scholars to explain why the market did this or that, and instead just focus on what I can control. Which is my investing behavior. My portfolio allocation and rebalancing enable me to tolerate any turbulence in the market, no matter what the cause(s) may be.
Great perspectives, Adam. Admittedly, for me, it’s far more about what sectors to invest in rather than strictly domestic v. global. Yes, rough start this year, quickly into negative territory but almost back to zero gain now as a total portfolio of holdings. Hang on tight and best wishes to all.
Any essay beginning with references to de Tocqueville is certain to be worth the read.
For what it’s worth (and as investment advice, it is surely worth little), I am one of those investors who think in terms of ownership of companies, rather than a slow-motion gambler interested primarily in the changing valuations of stocks. I relish, as an investor, the sense of an owner’s relationship with the world’s businesses. The world does better, the more that more of us realize how much, “We’re all in this together.”
I appreciate your starting my weekend out with a backward look toward our early days—back when we truly were the world’s youngest and “exceptional” democracy.
Regards,
(($; -)}™
Gozo
I hear you Adam. I still have about 12% of my equities in international equities. I was very tempted to dump it this year, but thankfully held onto it.
I am a strong believer in American exceptionalism. We tend to work longer hours than international counterparts and are very much goal driven. I worked with a number of international companies when I was a consultant, and compared to Americans, they are very laid back, and typically work less than 40 hour weeks.
Part of John Bogle’s philosophy was that most large US companies are global companies. Thus, he did not believe we needed to invest in global companies outside the US.
I always get hung up on allocation. When you say 12% of your equities, then can I assume it is a smaller percent of your total portfolio?
Yes, about half that for total AA
I’m not wishing for any I-told-you-so moments–I want all my stocks to win–but I’m glad I stuck with the Clements philosophy of diversification this year. And I’ll still be here next year, even if I don’t see a seeming justification of my stock mix. I also agree with your final observation: whether unexpected disease, government policy or the next exceptional event, it’s just part of doing business and a reason to have a portfolio to handle what ever comes along.