An April 2021 research paper by Vanguard takes a long look back at American and foreign markets and how relative weighting can shift over time. In 1970, American stocks represented almost 65% of all global equities. In the 1980s, with Japanese stocks soaring, the U.S. share had fallen to 29%.
This trend reversed course in the late 1980s, and by September 30, 2020, the U.S. market accounted for 58.4% of the total global market. It’s worth noting that the United States represents less than 25% of global GDP.
Aliaga-Diaz also suggests that foreign equities might provide more efficient inflation protection than current inflation hedge favorites like cryptocurrencies and commodities. Most of the developed world offers even more paltry interest rates than the U.S., and European stocks sport higher dividends.
Echoing Northern Trust’s McDonald, the Vanguard study found that global diversification smoothed out returns and reduced volatility. Specifically, the study found that an allocation of 35% to 55% to foreign equities was optimal when it came to reducing portfolio volatility.
Lower volatility isn’t the only factor advisors should consider. The last time long-duration U.S. tech stocks were shooting the lights out occurred in the late 1990s, when interest rates on 10-year Treasury bonds were in the 4% to 5% range.
Today those same bonds are yielding 1.5% and their counterparts in Europe and Japan offer even less income. In contrast, equities in these foreign developed markets offer more robust dividends than pricey U.S. shares. If the search for retirement income remains a global challenge for the next decade, it could favor stocks in developed markets with generous payouts.
Emerging Markets Change
Back in the days when the developing world provided the best returns, from 2001 to 2010, there essentially were two types of emerging markets—those with cheap labor like China and those with plentiful commodities like Russia and Brazil.
A decade makes a “humongous difference,” notes Santos. In 2009, cyclical stocks represented 65% of emerging market indexes. Today, that figure has fallen to 45%.
Nations like China, South Korea and Taiwan have become serious players in the technology industry. China has turned into “a tech innovator,” Santos says. Portfolio managers at American Funds said earlier this year in a webcast that they expect China to emerge as a major player in the bioscience and pharmaceutical industries over the next decade.
Longtime value investor and index designer Rob Arnott, co-founder of Research Affiliates, acknowledges this shift. “Emerging markets are more than just a label,” he says. “These economies are truly emerging.”
Arnott acknowledges that the negative sentiment and fears of another Covid wave have dampened enthusiasm for developing markets. “Five years from now, Covid will be a long-fading memory. Most narratives like [that] make attractive opportunities,” he adds.
Viewed through a valuation lens, Arnott notes that the Shiller CAPE ratio for emerging markets stands at 17, while it’s only 20 for the EAFE index and 31 for the S&P 500.
Conventional wisdom is embracing another narrative as the developed world emerges from the pandemic, namely that high-tech stocks are brilliantly positioned for yet another new paradigm. Even if true, Arnott believes this is fully reflected in investment prices and preferences.
But other asset managers are shifting their portfolios back toward the United States. Chris Mack, a portfolio manager at Harding Loevner, thinks that U.S. management teams generally adjusted to the disruption caused by the pandemic better than their foreign rivals.
It varies from industry to industry, however, and Harding Loevner finds excellent management teams outside the domestic market, Mack says. Taiwan Semiconductor, for example, is better positioned than Intel. But U.S. software concerns like Salesforce, Adobe and Microsoft are making the transition to cloud-based adoption more quickly than German giant SAP.
On balance, Harding Loevner is taking the contrarian stance and is positioning more portfolios toward the U.S. than it has over the last few years.