Following another year of U.S. stocks outperforming international stocks, many U.S. investors are asking themselves:
Do I need to own international stocks?
It’s a fair question. In the 15 years since the bottom of the Great Financial Crisis in March 2009, U.S. stocks are up around 10x, while international stocks are only up 3.6x (including dividends, but not adjusting for inflation). This means that U.S. stocks have outperformed international stocks by over 9% per year (on average) over the last decade and a half.
Additionally, given that 29% of the revenue for companies in the S&P 500 comes from overseas, you can see why U.S. investors may feel like they have enough international exposure in their portfolios already. Though I’ve written on international stocks before, with all these issues, you can see why another look is warranted.
To begin, let’s look at what is meant by the term “international exposure” and whether you need to own foreign companies to get it.
What is “International Exposure”?
When you ask a U.S. investor whether they have “international exposure” in their portfolio, they will typically reply based on whether they own international stocks. But not every investor looks at it this way. Corey Hoffstein, CEO & CIO at Newfound Research, argued in this episode of Two Quants and a Financial Planner that this definition of international exposure is misleading:
What is international exposure? If you are a U.S. company that does 100% of its revenue abroad, are you a U.S. company or are you an international company?…If you’re a French company that does 100% of its expenses and 100% of its revenue in the U.S., are you a domestic company or are you an international company?…We don’t care about where someone is listed. All we care about is where their revenues and expenses are.
I see Hoffstein’s point. U.S. investors seek out international exposure because they want to capture the economic activity (i.e. profits) of those markets. Therefore, how much does it matter where a company is listed? It doesn’t! As long as the company can generate a profit outside the U.S., then it qualifies. By this definition, many U.S. stocks provide some international exposure.
This argument is nothing new either. Jack Bogle, the founder of Vanguard, made a similar case decades ago when discussing why he didn’t own non-U.S. stocks. After all, if you believe that the institutions in the U.S. are the best in the world, then owning U.S. stocks with foreign revenues is the ideal way to get international exposure in your portfolio.
However, for some investors, myself included, this may not be enough. Though I believe that the U.S. has the best capital markets in the world, I also own companies listed on foreign exchanges in the event I am wrong. After all, the Roman Empire was the strongest in the world…until it wasn’t.
Of course, I would never bet against the U.S. because I have too much vested interest here. But I have no problems taking currency risk or owning assets abroad to offset any idiosyncratic risks related to U.S. stocks.
One such risk is the cyclicality of U.S. markets. For this, we turn to our next section.
Is U.S. Outperformance Just a Fad?
While there are arguments to be made about what constitutes “international exposure” there is no debate that U.S. stocks have outperformed the rest of the world in recent years. If you look at the rolling 10-year relative performance of U.S. stocks vs. the rest of the world (ex-U.S.), this is undeniable:
Looking at this data, there are two distinct periods of extended U.S. outperformance—the late 1990s and today. And what do these two periods have in common? The rise of U.S. technology stocks. Bespoke Investment Group recently created this chart illustrating this phenomenon:
Now that the U.S. technology sector makes up over 30% of the S&P 500 (as it did back in 2000), this begs the question: Is U.S. outperformance just a technological fad?
Maybe. This is why some have argued that U.S. stocks are experiencing DotCom Bubble 2.0. The euphoria surrounding AI today parallels that of internet companies in the late 1990s. While I see the similarities, the difference is that the earnings are much bigger this time.
The Magnificent 7 are the largest, most profitable companies in U.S. history. In a recent Eye on the Market, Michael Cembalest shared this chart showing just how profitable these companies are compared to the biggest companies in prior decades:
Based on this data, you can see why some have argued that U.S. stocks deserve their current valuations. But this isn’t the full story.
Because if you had this same chart back in 1999 (right before the DotCom Bubble burst), you could’ve made the same argument! But, you would’ve been wrong.
To see my point, just take the chart above and remove all the data after 2000. This is what an investor in 1999 would’ve seen (had they had access to such data):
At the time, the companies of the 1990s were the largest, most profitable companies in the U.S. since the 1950s. That’s great, but it didn’t stop the stock market from declining by ~50% within 3 years.
My point is that earnings alone don’t matter. It’s all about earnings relative to prices. If earnings grow better than expectations, U.S. outperformance is likely to continue. But will they? No one knows.
What we do know is that there is some cyclicality to U.S. stocks and that cyclicality is heavily dependent on the performance of the U.S. tech sector. Whether or not that sector will deliver on its promise remains to be seen.
The Bottom Line
If you don’t want to own international stocks because of the institutions or you believe that U.S. stocks are already sufficiently diversified, that’s fine. But realize that U.S. stock index funds have become a partial bet on the U.S. technology sector. I’d rather not bet too much on the U.S. tech sector, so I own international stocks and will continue to own them in the future.
Nevertheless, I am more open to the idea of not owning them than ever before. For most people, your allocation to international vs. domestic stocks won’t even be in the top 10 most important financial decisions you make in your life. How you grow your income, what you spend money on, and your career all matter so much more.
I don’t say this to trivialize the decision of investing in international stocks. However, it’s one piece of a bigger puzzle. I’ve owned international stocks since 2012 and have underperformed relative to U.S. stocks as a result. How much has that underperformance actually impacted my life? Not at all. I’d have about 7% more wealth in total if I had owned only U.S. stocks since 2012.
That’s not enough to retire early. It’s not enough to be financially independent. It wouldn’t change my spending decisions in any meaningful way. So before you agonize over whether to own international stocks, realize that it’s going to be far less impactful than many other financial decisions you will make in the future.
Happy investing and thank you for reading!
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This is post 435. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data
