By Wasif Latif, Head of Global Multi-Assets
Since early March 2009, the best answer for equity investors in terms of total return has been U.S. large caps – the Standard & Poor’s 500 is up more than 300% since the post-financial crisis bottom. Nowadays, however, that answer is being called into question.
A big part of the reason for the relative outperformance of U.S. stocks, particularly over the past five years, is that other stock markets have struggled to gain and then maintain momentum. This is the root of the “there is no alternative” rationale used by many asset managers to explain why they’ve been willing to pay ever-higher prices for that same dollar of S&P 500 earnings.
But we feel like there’s a transition in the making as international stocks start to shine – both developed markets (especially Europe) and emerging markets are producing better economic data and corporate results.
In 2017, European and EM stocks, each with total returns of 17% through May, are significantly outpacing U.S. stocks (+9%). And because those asset classes have not enjoyed the same sort of multi-year returns as U.S. equities, their relative undervaluation compared to U.S. stocks enhances their appeal. Investors looking for the next big opportunity are now piling in to take advantage of the opportunity.
As long-term investors, we were early to this trade in our asset allocation portfolios – we have been overweight DM and EM stocks for several years in anticipation that the rest of the world would get back on track and the performance gap between U.S. and global markets would narrow. The recovery under way now has taken a lot longer than we expected to materialize, but as a result of our focus on relative valuation, we hung in and waited for the market to come to us.
International stock rallies have been known to last for years, so once we were confident that conditions were shaping up, we swapped expensive assets for cheap ones by trimming our allocation to U.S. stocks and adding to our overweight global equities.
As members, you have your own asset allocations to manage. There are, of course, a lot of individual factors that figure into each investor’s decision-making – these include risk tolerance, time horizon and cash flow needs. On the risk side, we would suggest you ponder a couple of basic questions that may help you with your equity positioning.
Are you diversified enough? There’s an old and often-repeated adage, “Invest in what you know.” U.S. investors know U.S. companies, so they tend to concentrate their equity allocation in the domestic market. This so-called “home bias” is not unique to Americans, but it can affect both risk and return.
On the return side, there’s an opportunity cost – the U.S. stock market accounts for less than 40% of the global stock market, so not looking outside the national borders means less chance to share in potentially the vast amounts of wealth being created in dynamic economies around the world. On the risk side, U.S. stocks have soared since 2009 to valuations we believe are well above their long-term average by any measure. As a result, U.S.-centric investors may have too much of their wealth exposed in the event of a market drop.
Are you prepared for a volatility upswing? The U.S. stock market has been unusually placid for some time now – up days or down days of more than 1% have become such rare happenings that they make for big headlines when they do occur. International markets are also calm in terms of daily price swings.
But just because markets have been docile doesn’t mean they’re going to stay that way. We believe investors should be prepared for more volatility – rich valuations for U.S. stocks make them especially vulnerable. At the same time, we caution members investing for the long term to not overreact in the event of a short-term event that roils markets. What looks earth-shaking over a day or even a week often smoothes out over time.
As we come into mid-year, and with the possibility that a major global equity shift is under way, now might be a good time to take stock of where your portfolio stands. We encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles may be suited to you based upon your individual goals, risk tolerance and time horizon.
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Diversification is a technique to help reduce risk. There is no absolute guarantee that diversification will protect against a loss of income.
Investments in foreign securities are subject to additional and more diverse risks, including but not limited to currency fluctuations, market illiquidity, and political and economic instability. Foreign investing may result in more rapid and extreme changes in value than investments made exclusively in the securities of U.S. companies. There may be less publicly available information relating to foreign companies than those in the U.S. Foreign securities may also be subject to foreign taxes. Investments made in emerging market countries may be particularly volatile. Economies of emerging market countries are generally less diverse and mature than more developed countries and may have less stable political systems.
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