Another day, another item of investing advice lands in my inbox claiming that we American investors shouldn’t waste one nickel of our IRAs and 401(Ks) on those inferior foreign (yuck!) stocks.
Stock markets in places like Western Europe, Japan and Australasia will get you all the risks of Wall Street with less of the upside, goes the claim. And those in so-called emerging markets, such as China (yikes), Russia (double yikes), and so on are arguably even worse, they add.
There is nothing new, unique or rare about this line of argument. Those pushing it (including, I suspect, many financial advisers) can point to some superficial data to back up their case.
For example, since 1970 U.S. stocks have produced double the overall return of the leading index of developed international markets, the Europe, Far East and Australasia or EAFE index. And since the financial crisis, U.S. stocks have beaten foreign stocks in three years out of four. And here we are again, in 2023: the S&P 500 is up 14.5%, the MSCI EAFE index EFA, which tracks developed markets outside of the U.S. and Canada, less than half as much, at 6.8%.
There are only two problems with this line of argument. The first is that it is based on superficial math and bad logic. The second is that this argument tends to become most popular, and get most widely repeated, just around the time it is absolutely the worst advice to follow.
Telling ordinary people to avoid international stocks altogether is terrible investment advice. It makes no sense whatsoever.
And it makes the least sense for precisely those most likely to be subjected to it: Namely regular investors who aren’t trying to trade in and out of markets based on short-term moves but who are trying to invest over the long-term for their retirement.
I remember vividly hearing much the same around 1999-2000, after another decade when American stocks had done particularly well. Even the late, great Jack Bogle back then was heard saying American investors didn’t really need anything other than the S&P 500.
Over the next decade, developed international stocks made you about 30% (and emerging markets more than 250%).
The S&P 500? Er…about 0%.
Before inflation, which was not 0%.
Emerging markets are a different subject for a different day—especially now that China and Taiwan make up nearly half the entire emerging markets index, which means a substantial amount of your stake is going to depend on which side of the bed Chinese premier Xi Jinping wakes up on each morning.
But when it comes to developed international markets: The only thing we can really say with any great confidence is that they have tended to do better at different times. Since 1970, it’s true, the overall U.S. performance has been twice that of the EAFE index. But all of that outperformance has been in the past 10 years.
From 1970 through 2013, the total performance was even. And it came at different times. You wanted to be in international stocks in the 1970s and 1980s, when they produced double—yes, double—the U.S. dollar returns of the US. You wanted to be in U.S. stocks in the 1990s and over the past decade. You wanted to be invested in international stocks during the zeros (or at least for most of them, through the end of 2007).
Since 1970, international stocks have produced higher returns than U.S. stocks in 27 years. U.S. stocks have produced higher returns in 26.
If you split the developed world even further into the U.S., Europe and the Pacific, you’ll find that the U.S. has been the best performer in 19 years, the Pacific in 15, and Europe in 10.
Someone investing only in the U. S.—or in any particular country or region, for that matter—greatly increases their risk of one of those terrible “lost decades” that has devastated previous generations of investors.
Anyone who stuck only with U.S. stocks in the 1970s, for example, actually lost money. After counting inflation, an investment in the S&P 500 in 1979 was worth about 10% less than it had been in 1969, even when including reinvested dividends.
Meanwhile, international stocks beat inflation by around 30% over the same period.
Meanwhile, the latest market data from SG Securities says that U.S. stocks are currently trading on a lofty multiple of 19 times forecast earnings for the next 12 months, compared with 14 times for Japan, 13 times for the rest of Asia-Pacific, and 12 times for Europe. When we buy U.S. stocks we are paying nearly 50% more for each $1 of earnings.
One of the reasons the performance of U.S. stocks looks so good in recent years is because they have become so expensive in relation to earnings. To extrapolate the same trend in the future is to make a beginner’s mathematical error.
The U.S. accounts for about 45% of the annual economic output of the world’s advanced economies, according to International Monetary Fund data. And U.S. large and midsize stocks account for a comparable share of all the large and midsize stocks in developed markets. It’s hard to see why a long-term investor saving for their retirement would hold much more than 50% of stock market allocation in U.S. stocks—let alone 100%.