Recent returns for Americans holding foreign market investments have been underwhelming. But, it’s still a great idea to maintain a meaningful allocation to foreign markets.
Now is a perfect time to take advantage of the best relative valuations in 20 years. For a variety of reasons including strong dollar, and a later recovery than America from the unfortunate events of 2008 and 2009, foreign stocks are on sale.
It’s counterintuitive to hold or purchase stocks that have recently disappointed us. However, it’s axiomatic that the cheaper you buy stocks the better your forward looking expected returns are.
Keep a long term focus
We all focus on recent events. In a world where the stock ticker crawls across the bottom of your news feed every second, three days seems like a long term, and three years is an eternity. Yet, even ten years isn’t really a long term horizon.
It takes patience and discipline to execute a rational long term investment strategy. Something in your asset allocation is always disappointing you. The temptation is to dump it and chase performance which is never a good idea. Fortunately, for long term investors a disciplined process of rebalancing enforces a systematic buy low – sell high policy without making guesses as to market timing.
Diversification is the investors best friend. It both increases returns and reduces risk. Global diversification is the gold standard.
Depending on how you measure it, he US market is somewhat less than half of the world’s tradable securities. Of course, we all have a local market bias. We feel more comfortable investing in things we know, or at least think we know. But, there are great companies and markets outside our borders that merit your participation. Historically foreign investing has offered strong equity returns and a valuable diversification benefit.
There is no good reason to believe that a German investor should expect a different long term return in his portfolio than a US investor expects. Otherwise capital flows back and forth until expected returns are equal. So over a full market cycle we should expect reasonably similar results.
Those periods of over and underperformance may drag on for a while. They have both been good long term investments, but have dramatically different short term results.
Foreign markets have a long history of trailing domestic stocks and then suddenly reversing to outperform them. They are, after all, a different asset class.
Below illustrates the annual under or over performance of our S&P 500 stocks versus the diversified foreign stock index EAFE (Europe, Australia, Far East) since the 1970 inception of the EAFE index. Values above the line indicate S&P 500 outperformance while values below the line denote EAFE outperformance. Note how suddenly and dramatically performance between the asset classes can reverse.
We would all like to know just those turnarounds might occur, but that’s not going to happen. Unfortunately we don’t get a heads up. However, based on past history we know it will happen. When that day comes, you need to be on board.
Differing short term returns are actually a very good thing. Ideally we are looking for asset classes with strong equity returns and low correlations to one another. Foreign stocks offer those qualities.
Admittedly, holding or buying any asset class that’s down is frustrating but has the unassailable advantage of always having worked before. But, long experience indicates it’s the prudent course that adds value over time. So, continue to maintain a healthy allocation to foreign equities. Stay the course. You will be glad you did.