- Tom Naratil, UBS’s president of the Americas and co-president of the firm’s global wealth management division, says recent stock market volatility should have investors reconsidering their geographic allocations.
- He makes the case for stocks outside the US, and urges investors to consider making their holdings more globally diversified.
The sudden bout of weakness in the US stock market should serve as a wakeup call for investors who had started to see their domestic market as the only place to be.
For most of this year, US stocks forged ahead while markets in the rest of the world struggled. Yet, with the US market recently succumbing to the worries plaguing other markets around the world, now is a great time to rebalance US portfolios to ensure that international stocks and other assets have a proper allocation. Given that the US has already had such a strong run, a globally diversified investment approach is likely to produce even better results over the longer term.
To be clear, despite October’s sell-off, individual US investors are still upbeat about the prospects for stocks. According to a UBS Investor Watch Pulse survey conducted after the midterm elections on November 9-14, just 14% of US high net worth investors believe it’s time to get out of the market, compared with 22% pre-election. Furthermore, US business owners who responded to the survey also grew even more positive on the robust 12-month economic outlook, with 73% expressing optimism compared with 67% pre-election.
However, our advice to American clients is to translate that enthusiasm into global equities, rather than sticking solely to the US. Over the five years to November 23, US stocks gained 60.1% as measured by the Russell 1000 index, compared to just 8.0% for emerging market stocks and 9.4% for developed market equities excluding the US as measured by MSCI. Although 2017 saw international equities outperform US peers, 2018 has so far seen a return of this trend. As a result, many US investors have come to feel that there is no place like home, and have been inclined to shy away from international exposure. However, we still believe that investing globally is one of the best long-term strategies for a number of reasons. First, it is unlikely that any market can outperform all the time. US stocks drastically lagged emerging and non-US developed markets from 2002 to 2007, with MSCI Emerging Markets gaining 353% and MSCI EAFE (developed non-US) returning 129%, versus just 43% for the S&P 500. Since 1999, the US has only topped the ranks of countries’ equity markets once, while emerging markets have come out in the lead in nine years. The growing maturity of some emerging markets may also increase their potential. For example, Warren Buffett, who has long been cautious about India’s stock market, this summer invested in the country’s maturing fintech sector for the first time. Second, the conditions that produced the recent US outperformance show signs of fading. The earnings boost from the 2017 US tax cuts, which has propelled stock returns this year, will likely ebb over the coming year. Additionally, profit margins for US companies are close to their historic highs, whereas they are still depressed in both emerging and other developed markets. Valuations in the technology sector, which has been responsible for much of the US outperformance, are also no longer as appealing as they were a few years ago. Third, other regions look to offer more compelling long-term value. As of November 23, as a multiple of future earnings estimates, the US stock market was valued in line with its 30-year average. In contrast, emerging markets, whose economies are growing faster than the US, were trading at an 18% discount to their three decade average, while non-US developed market stocks are at a 23% discount. Furthermore, because the US economic and earnings cycles are more advanced than other regions, other markets are likely to outperform in the coming years.
Our chief investment office’s market models now assume non-US equities will produce annual returns between 1-2 percentage points more than US stocks over coming years. Over the next market cycle, excluding international equities could result in a drag of greater than 1 percentage point on portfolio returns-a hefty cost in an environment where forward-looking returns have become precious.
Today, an understanding of economic conditions and trends in all markets is essential to optimising any sophisticated investor’s decision-making process. According to financial theory, allocating too much of an equity portfolio to a single country increases risk – through higher volatility and more painful losses – without leading to better returns. A globally diversified approach should lead to a better risk-adjusted rate of return and likely a more comfortable investor experience.
Harry Markowitz, the father of Modern Portfolio Theory, once called diversification “the only true free lunch in investing.” In today’s environment, investors who look for opportunity and value both at home and abroad are the likely to be the ones to sustain and grow their portfolios in the long run.
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