The U.S. stock market has been the darling of investors for over a decade. A constructive question arising from recent history would be, why should one invest outside of the U.S.? In short, diversification.
U.S. outperformance originated with the reaction to the financial crisis. Central banks implemented unconventional monetary policies such as quantitative easing, which artificially suppressed interest rates. Low interest rates encouraged business investment and emboldened investors to bid up stock
prices. The strong dollar further enticed foreign investors to pursue U.S. stocks, boosting U.S. stock prices even more. In the end, the high demand for U.S. stocks resulted in the current lofty stock valuations.
Implementing or maintaining a healthy international exposure can help mitigate U.S. stocks’ premium. By unintended omission, international stock sector exposure has evolved without an overbearing technology sector. The U.S.’s fondness for entrepreneurial sweat equity has favored companies with easier business formation and quicker R&D cycles. No industry has generated as much innovation as technology, hence the ultimate U.S. technology overweight. On the other hand, European, Australian, and Japanese business formation favored institutional approval, often accompanied by bank funding, with clearly defined business objectives and pro forma financial projections. In other words, slower-moving companies making carefully calculated risks.
Different sectors result in different revenue streams. Different types of companies serve different consumers. Technology alone can’t solve healthcare issues, build cars, brew coffee, sew garments, or mine iron ore. International companies have maintained a better balance of companies and sectors, resulting in different revenue streams, customer bases, and product offerings.
Many investors incorrectly equate a foreign company with the foreign country. Hence, investors think a German company is an investment in Germany. This couldn’t be further from the truth. In general, foreign companies derive a larger percentage of their revenues from abroad compared to U.S. companies. Hence, international companies have access to opportunities that U.S. companies don’t.
International markets tend to favor more traditional, slowly growing industries with more consistent earnings. These characteristics are attributable to value stocks, or companies with enduring brands and regular cash flow. Value stocks can be thought of as a ballast to growth stocks, stocks that may be growing faster than the overall economy, but also prone to missteps. The U.S. is not absent value stocks, but the recent high technology weighting curtails the value stocks’ contribution.
Investors should seek to diversify by sector, style, revenue generation, and geography. International stocks satisfy all these attributes. Maintaining a healthy international weight is a wise portfolio decision that we anticipate will have durable effects.
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