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Should You Add International Exposure To Your Portfolio Right Now?
Since the Great Recession, few markets have provided returns superior to the U.S. equity markets. Between 2010 and 2019, the S&P 500 gained nearly 190%.
That strength has continued this year and is being led by gains in the technology sector.
Having a U.S.-centric portfolio would have served you well over the past decade. Most sectors enjoyed double-digit, if not triple-digit, percentage growth over the past 10 years. Even the energy sector, as measured by the Energy Select Sector SPDR ETF (ticker: XLE) saw its price rise two-fold between 2009 and 2014, before reversing trend since then.
Conversely, many major international equity indices failed to provide strong returns. For example, between 2010 and 2019, a diversified investment internationally, as represented by the iShares MSCI EAFE ETF (EFA), returned a little more than 20%. This pales in comparison to major equity index returns in the U.S.
Mind the Gap
There are a few reasons why developed international markets have lagged behind the U.S. so badly over the past decade. These include aging demographics, lack of innovation and lack of restructuring within mature companies.
Poor demographics are best seen by analyzing Japan. The benchmark stock market in Japan, the Nikkei Index, enjoyed strong gains in the 1980s. Between 1975 and 1989, the Nikkei index rose from 3,717 to nearly 39,000 in 1989. During that time period, the index rose every year except once, when it fell by 2.5% in 1977.
Japan enjoyed population growth during most of that time, but by 1987, its population growth rate declined to less than 0.50%. That was the lowest growth rate in over 30 years and Japan’s population continues to decline. Today, the Nikkei level remains below the highs seen in the late 1980s, despite a few strong years recently.
Look no further than China when discussing how important innovation can be. In its 2020 China consumer report, McKinsey & Company reported that growth in urban consumption is the main driver of the Chinese economy. Unfortunately, this has not translated to exponential growth in its stock market.
For a U.S. investor, one way to gain exposure to Chinese equities is through the SPDR S&P China ETF (GXC). Despite the massive gain in purchasing power for many people in China, GXC is currently trading around the same level it was back in October 2007 when it peaked at $113.55.
Time to Reallocate
Is now the time for developed international markets to outperform?
Developed markets outside the U.S. may have lagged over the past decade, but investors may increase their allocation to them for a few reasons over the next decade.
There is plenty of debate in the markets about rebalancing from growth to value stocks. Many growth stocks are not cheap, especially when considering respective price-earnings (P/E) ratios. In the U.S., you could add energy or even financial stock exposure to your portfolio, but there are plenty of questions on the outlook of both sectors that may prevent you from doing so.
Many developed international markets would be considered cheaper when judging by their P/E ratios. This includes Germany, where the iShares MSCI Germany ETF (EWG) has a much lower P/E compared with the S&P 500.
Although the equity market in China as represented by GXC has lagged the nominal economic growth of the country, we are starting to see more innovation. Not a day goes by when TikTok is not in the news. Then there are the well-known companies of Alibaba (BABA) and Tencent Holdings (TCHEY). Besides GXC, if someone wants more concentrated exposure to China, which also means more volatility, the EMQQ Emerging Markets Internet & Ecommerce ETF (EMQQ) places an emphasis on three sectors: China, consumer cyclical, and communication and technology.
Of course, these are not recommendations; this is merely information on some available funds that can be used to provide international exposure.
U.S. companies were quick to restructure after the 2008 financial crisis, which can be seen in the appreciation of individual stocks. Many companies in Europe have been slow to restructure. This begs the question of whether there will be a shift in the capture of business efficiencies, which will be expressed in company profits in the years to come in Europe and other developed nations.
The U.S. economy has been severely slowed by the global pandemic. Arguably, other nations have fared better and because of that, they may be better prepared for their markets to perform over the next year or two.
The political landscape in the U.S. has many unknowns. That alone has some people more interested in investing in other developed nations. Not only could the U.S. election outcome be contested, but the lack of unity may lead to a less unified fight against the health crisis.
Takeaway
Investors have generally fared well when investing in the U.S. over the past decade. This is especially true when comparing returns seen in the U.S. with equity returns seen internationally. Trends do change though, and investors may be becoming more open to allocating investments outside the U.S., given the issues in the U.S. and opportunities that may await overseas.
