The wealth management industry has become plagued by cookie cutter portfolios with a standard mix of 60% stocks and 40% bonds; the goal being to perform no better or worse than the guy next to you. With current valuations in the U.S. stock market, the standard large allocation to U.S. equities exposes investors to unnecessary risks at the opportunity cost of investing in more attractive asset classes. In this article we will provide an overview of why international stocks and emerging market stocks should be a core holding in the current market environment.
Investors tend to buy more of what’s been going up instead of rebalancing, which we all know we’re supposed to do. But often acting on short term pressures sacrifices long term results. As U.S. stocks continue to perform well, investors pile more and more money into them. The fear of missing out drives investors to take undue risks while chasing after recently strong past returns. If you have ever read the disclaimer at the bottom of a investment prospectus, they make it clear that past performance is not a guarantee of future returns. Combine this mentality with historically high valuations and it is easy to see why we look elsewhere for a large portion of our equity allocation.
Developed international companies and the economies they operate in were slower to recover from the 2008 financial crisis than the U.S. As a result, they have not experienced the crowding that the U.S. stock market has witnessed. The lack of mainstream interest in these markets leaves them at attractive valuations relative to the U.S. market while operating in economies more in the midst of recovery than in the late stages. Emerging market economies saw an even longer delay in their recovery from the financial crisis. The turnaround in emerging markets creates attractive growth prospects, again at more attractive relative valuations than the U.S. equity markets.
Of course, different equity markets come with different risk profiles. Emerging markets are historically more volatile than U.S. markets while developed international ones may have lesser growth prospects than the U.S. And of course, investing outside the U.S. brings with it currency risk exposure. As always, there lies a balance in weighing the risks and future prospects against the relative valuations of the different markets. Even with these discrepancies we still believe that non-U.S. equities broadly present more relative value than the U.S. market.
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