The Case for International Stocks

Written by Rick Welch

In our view the case for adding international stocks to a portfolio of US stocks is the strongest seen since the market bottom in March of 2009.  In 2017, international stocks (ACWX ex-US) returned an impressive +24.04% compared to the +19.42% return of the benchmark S&P 500.  This marked the first year since 2012 that international stocks had outperformed US stocks. While US stocks have largely advanced during a nine-year bull market, international stocks have faced many obstacles including sovereign debt crises across southern Europe (remember PIIGS), BREXIT, slowing growth in China, a dysfunctional OPEC and plunging commodity prices that roiled many emerging markets. Central bankers around the world were slower to react to worsening economic conditions than our Federal Reserve with the result being that many international economies are farther behind in their cyclical recovery from the global financial crisis of 2008-09.   This independent movement of global economies, which react differently to factors such as monetary, fiscal and economic growth cycles, has and should continue to provide the basis for significant benefits for the investor who holds international stocks in combination with US stocks.

We think the rationale for adding international stocks to a portfolio of US stocks is clear. US stocks are exposed to US economic and market forces, while stocks domiciled abroad offer exposure to a broader set of economic and market forces. This exposure is different than when a US based multi-national company (like McDonald’s) generates a significant portion of their revenue from foreign operations.  International companies often respond more to local economic and geopolitical events than those emanating from outside their borders and can often capitalize on such events more adeptly than US based companies operating there.  International companies often benefit from the fact that different countries’ economies often lean towards different market sectors or industries. Global growth expectations remain strong with the International Monetary Fund (IMF) projecting 3.9% growth for 2018 and 2019, compared to US growth forecasts of 2.9% (2018) and 2.7% (2019). The optimistic growth forecasts aside, international stock valuations today appear more reasonable with the ACWX ex-US currently trading at a forward P/E of 14.1x, which compares favorably to the 16.3x (down from 18.4x on February 1st) of the S&P 500.  We believe the combination of favorable growth forecasts, improving fundamentals and reasonable valuations support the increasing of exposure to international stocks during the remainder of 2018 and into 2019.

To better visualize how a combination of US and international stocks might perform, we should focus on the cyclicality of their investment returns over time.  To do so, we will consider return data for the period of 2000-2017.  During that time period, US stocks outperformed international stocks in 9 of 18 years, or 50% of the time.  The period average return for US stocks was +7.03%, while international stocks returned +6.79%. But, there is more to this story.  The longest streak of US stock outperformance was four years (2013-2016) during which time US stocks returned +14.85%, while international stocks returned just +2.56 %.  In contrast, in six consecutive years (2002 - 2007), international stocks performed better (+15.67%) than US stocks (+7.28%). This pattern of cyclical performance rotation suggests that a risk-adjusted portfolio should hold both US and non-US stocks. Thus far in 2018, international stocks have performed slightly better than US stocks and look to make it two years in a row.  The question investors must now ask is if this is the start of a new streak of international stock outperformance or not. 

Website Design For Financial Services Professionals | Copyright 2018 AdvisorWebsites.com. All rights reserved