International Investing: S&P 500 Not the Only Game in Town

Nobody should be asked to adopt the mantra of a 20th century Chicago Cubs fan who reacted to decades of losing by saying, “No need to get upset. Everyone has a bad century now and again.”

International investors can relate.

While it hasn’t been a century of poor returns for international stocks, for some, it may feel like it. Especially when compared against U.S. stocks.

Many have called the past 10 years “a lost decade” for international stocks.

As can be seen in the below chart, the blue bars are periods where international stocks outperform, and the red bars are when U.S. stocks outperform. Recent history has many more red bars than blue bars. 

The recent history for international stocks has been in a word, terrible, at least when compared to U.S. stocks. For the decade that ended in December, the total cumulative returns can be seen below.

U.S. stocks beat international stocks by more than 200% and did so with less volatility.

But history shows performance swings back and forth, it’s not uncommon for outperformance of one region to remain persistent over several years.

Last year’s growth- to-value “regime change” was much talked about. Using large cap indices, value had its most meaningful outperformance versus growth since 2016. This invites the question: could another regime change be afoot elsewhere?

For the first time since the Great Financial Crisis, U.S. stocks have underperformed global peers for more than one year. Though the last decade was so decisively one sided you need to squint to see the recent international outperformance.

This could be a mere blip, as some have been in the past. It’s far too early to proclaim a regime change with high conviction, but at the very least, investors should be paying attention.

There’s the old saying, “trees don’t grow to the sky.” If something cannot continue forever, it must stop. In an honest moment, could you convince yourself U.S. stocks will outperform forever?

Something we often like to remind investors: the U.S. is a huge equity market, but it’s far from the only game in town. The U.S. equity market represents 60% of the global equity market cap, meaning the other 40%–not an insignificant number–of global market cap exists outside the U.S.

In addition to market cap, there are many other benefits of investing internationally that broadens the exposure to:

• Population: U.S. is only 5% of the global population.

• GDP: U.S. is only 25% of global GDP.

•  Market breadth: 85% of all public equities exists outside the U.S.

Market breadth—generally defined as the number of stocks in an index increasing in price—is particularly interesting. Despite international stocks underperforming the last decade, many of the best performing stocks in any single year have been outside the U.S.

In short, having some international stock exposure is generally a smart asset-allocation policy.

A Long History of Changing Leadership

The below chart is one of the most important reasons why diversifying internationally is important.

From the Credit Suisse Global Investment Returns report, the pie chart on the left shows the size of the global equity market in 1900, while the pie chart on the right shows the same data at last year end. Items to note:

•  At the start of the 20th century, the U.K. equity market was the largest in the world, accounting for almost a quarter of world capitalization, dominating the U.S. (15%).

• Over the next century, U.K. stocks fell to 4% of total equity market cap while U.S. stocks went from 15% to roughly 60%!

Different countries had widely differing fortunes over the last 100 years. It seems plausible this will be true in the future as well. Hitching your assets to a single country is not a smart thing to do. 

What Should an International Allocation Look Like?

The most practical advice–for the masses—would likely be to match the global equity market cap. In effect, try to mimic an equity allocation that represents 60% U.S. stocks and 40% non-U.S. stocks. This would purely be intended as a starting point, or framework for how to think about diversifying between the two.

Of course, it’s impossible to give advice to the masses; it should be personalized. The exact allocation to non-U.S. stocks should likely fall in a range depending on age, circumstances, and risk tolerance.

For younger investors, maybe they match or even exceed the 40% allocation to non-U.S. stocks. For older investors, they might arrive at a smaller allocation given international stocks tend to exhibit higher volatility.

There’s also the possibility of using new investment dollars to increase or decrease the allocation. When international stocks underperform, you could put new contributions into international stocks to bring your asset allocation back in line with your written investment plan. When U.S. stocks underperform, you should do just the opposite.

There’s always caveats but that’s generally a good framework for considering an allocation.

Takeaways for Investors

If you go fishing, there’s one simple rule to remember: fish where the fish are.

Do you want to limit yourself to half the lake or seek out the best opportunities where available? Investing shouldn’t be any different.

International stocks have underperformed over the past decade, but this not an anomaly historically. Markets move in cycles. What trails will often end up leading, given time.

Diversifying outside of U.S. stocks provides important benefits for investors, providing significant exposure to a portion of the worlds market cap, stocks, GDP, and population that can’t be replicated investing in the U.S. alone.

The Cubs World Series title in 2016 cured a century of pain for Cubs fans. A few good years of international equity returns could provide a similar remedy for equity investors.