What A Start
Just like that, 2023 is off and running. And for Americans with investments in international stocks, what a start it’s been.
Stocks in developed markets like Japan, Canada, and many countries in western Europe have already gained over 6% in the first few weeks of 2023. Stocks in emerging markets like China, India, and Brazil are up about 7.5%. Numbers over the past three months are even stronger, as shown in the chart below.
Returns like this tend to draw investor attention. Why have these stocks performed so well, and more importantly, will it continue?
The U.S. dollar is one reason international stocks have fared so well. Over the last three months, the U.S. Dollar Index (DXY) has dropped by nearly 9%. We wrote about the relationship between the dollar and international stock performance (for U.S. investors, at least) in a previous note so we won’t go into much detail here. In short, a stronger dollar is a headwind for international stocks, just as a weaker dollar is a tailwind.
Valuations and dividend yields also appear supportive of international stocks, at least on a relative basis[1]. But that is nothing new. Foreign stocks have appeared ‘cheaper’ than U.S. stocks based on a number of metrics for what feels like an eternity now.
Despite that, investors in foreign stocks have experienced little more than disappointment over the last 15 years. The chart below compares hypothetical growth of $10,000 in the S&P 500 to international counterparts. Seems like a no-brainer, right?
In spite of this long-term underperformance, there could be another reason to reconsider your mix between U.S. and international stocks: diversification.
One of the primary arguments for including foreign stocks in our investment portfolios has been diversification. Owning companies in Europe, Asia and other parts of the world might be able to improve returns, reduce risk, or both. At least that was the thought. And for several decades, foreign stocks seemed to move a little differently than domestic alternatives.
The chart below shows correlation between those foreign developed markets and the U.S. by decade. Through the 1970s, 1980s and 1990s, correlations were relatively low, which strengthens the diversification argument. Over the past three decades, however, they have tended to move in the same direction quite often, with correlations near 90%.
Increased globalization characterized most of the last three decades, and that trend may be reversing or at least slowing. U.S. companies stung by recent supply chain disruptions seem much more interested in bringing back parts of the process to the U.S., even if it is a little more costly. Impacts from trade wars in the late 2010s may still linger as well.
Will that be enough to turn the tide, from an investment perspective? And could investors benefit by rethinking how they invest around the world? This could be an ideal time to revisit that conversation.
Interested in talking more? Email me at eric@divviwealth.com or set up time with the Divvi team to continue the conversation.
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