The US has reigned supreme for a number of years now in terms of equity returns. The S&P 500 was the top performing “national” index in the 2010’s returning 182% over the decade. Tech let the way and if you were even longer tech, like investing in the Nasdaq 100, you didn’t even better returning over 300%. It’s not fair to say all the tech titans are located in the US. There are companies like Samsung and Huawei that are leading edge companies internationally. In fact, Huawei is so far ahead in 5G technology, the US government has stepped in to try and quell the rise of the company as it has no answer in terms of technology and internet speed.
Those however, are the exception. For the most part, in terms of products, innovation, data science and more, large US companies lead the way. Microsoft, Google, Facebook, Apple and Amazon are crushing all other equity returns, even in the US. If you go further out and look internationally, returns have lagged the US as well. What this has meant is that the big winners have been in US tech the past 10-15 years. First the Nasdaq 100, then the S&P 500 then international stocks. In fact, given that many large US companies are already diversified in terms of their global revenue, it’s enough to have some people asking, why even invest international at all?
It’s More Complicated
As I mentioned, it’s true that the US has done the best over the past decade. The pandemic hasn’t changed this, the US has bounced back. For all the doom and gloom, the S&P 500 is defying gravity and has climbed back above 3,000 while the Nasdaq is approaching its all time high again. Over the long term, the US has done better than most markets as well. It’s one reason that over 50% of the entire market capitalization in the world consists of US stocks. The US share of the market has fluctuated over time though. It has been as high as the 60% range to as low as the high 20% range over the past 50 years. When you are looking at the long run, this is what you want to take into account and one reason diversifying internationally matters.
Source: Vanguard
I talked about the top performing stock market of the 2010’s but if you had to name the top performing market of the decade for the year 2000 what would you guess? The answer is Norway, whose market gained 48% over the decade, followed by Brazil. The US wasn’t even in the top 10. However that the hangover after the roaring 90’s where US stocks did very well. However you may be surprised to also learn that the US wasn’t even the best performing market in the 90’s either, that went to Switzerland. In fact, the 2010’s was the first time that the US was the top performing global market in the past 100 years.
Source: Bridgewater Associates
The strength of the US market has not been that it is the best performing market every year but rather that it offers consistently pretty good returns to investors who stick with it long term. Compared to other international markets, it has still done better over the long term.
Source: Bridgewater Associates
The above charts the returns of some major international indexes since 1900. You can se the Russian one drop to 0 after the Bolshevik revolution and even those that did not have wars or revolution still didn’t do as well when you use 1900 as the starting point for cumulative returns. You may notice however, the black line, which is an equally weighted portfolio of international indexes. This has performed almost as well as the US only index but with less volatility. You may also notice in the grid above that the US market has only outperformed this equally weighted index twice in the last 100 years, both of those times being recently in the 90’s and the 2010’s.
Why International Has Underperformed Recently
When you break it down by sector, all the growth of the 2010’s has essentially come from tech in the US. It’s one reason that the IT sector now makes up 26% of the S&P 500, it makes up for more than half of the Nasdaq 100. International stocks have underperformed as of late because this sector is underrepresented in the international portfolio.
Source: The Capital Group
All the things that have been poor investments in the recent past have strong representation in stocks outside the US. This includes materials and energy, which have both gotten stomped since the financial crisis.
Don’t forget though, that even as sectors, these cover a wide swath of companies. Energy doesn’t have to mean dirty energy like coal and oil, as new green energy companies spring up, some offer growth opportunities. This is an area where the US is behind and Europe and Japan are at the forefront. The need for materials will not go away and as the Fed and other central banks balloon their balance sheets to finance massive government deficits, the temptation to inflate a part of the burden away will increase in the coming years. Materials are one asset class that isn’t correlated with the growth of money and could become a favorite again if inflation rears it’s head.
Underperformance is also part of a super cycle that ebbs and flows over long stretches of time. There have been a number of periods when the US has outperformed international stocks for many consecutive years only to reverse course to see international then outperform the US for a number of years.
Source: Vanguard
The Homs Bias
In the US we tend to look at the world through national eyes. A crisis in the US is a crisis everywhere and there is some truth to that, but we are not always the whole story. Many of the years when the US has underperformed, other markets have picked up the slack and done well. The issue is partly what is called our home bias, that we are so focused on our own market that we lose sight of what is happening elsewhere and the other is the media attention intensified on stocks during periods of falling prices.
This tends to put blinders on many of us as to what is going on elsewhere and ignore the fact that other countries may be doing quite well as times that US equities flounder. The typical US portfolio is even more tilted towards the US than even the global market index is.
Source: Bridgewater Associates
I would venture to say that this portfolio is reflective of the more wealthy in the US as well since it includes a portion for hedge funds and commodities, something most small investors don’t have much direct exposure to. The rich are supposed to be the best informed and have their money managed by the best people and even they tend to have a home bias which exposes them to the downside of the US and missing the upside of the rest of the world.
More Reason
So if less volatility and risk with almost as good performance over the long term by investing internationally doesn’t move you, maybe the dividend yields will catch your attention. Over the 81 year period from 1926 to 2007, dividends have accounted for about 95% of the long term return of the S&P 500. It’s been shown that stocks with higher dividend yield have outperformed those with lower dividend yields over time. This is even more of a factor now given that interest rates have been so low across the rich world. The low rates have contributed to a rally in the utilities sector, where dividend yields are high, which has been lasting over 10 years.
While everyone has been piling into tech stocks in the US, dividend yields have seen some all time highs compared to yields in the US. As rates have fallen again with the pandemic and the economic fallout of lockdown, yields have all of the sudden become more important for income again. Below is a chart of yields of stocks outside the US as of August of 2019, well before the current crisis, so keep in mind the number of companies yielding more than the US market is even larger now.
Source: The Capital Group
How to Diversify Internationally
When you don’t know a particular market in depth or are just starting out, I always advise it’s best to start with a diversified ETF which tracks the market index. This can be done easily through some of the largest asset managers.
Vanguard offers VXUS which offers the whole world of stocks outside the US. You can also capture everything through VT which captures the whole world including the US.
If you want to focus on dividends, Wisdom Tree offers a high dividend yield fund DEM and Vanguard offers an international dividend appreciation ETF VIGI. In addition to these, iShares by Blackrock offers the most individual country ETF’s if you have particular markets you want to take exposure to.
If your aim is to buy low and sell high, there is no better time then now to take advantage of the downturn in markets outside the US. Dipping your toe into a broad diversified ETF could be a good start to smoother returns over the long run.
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