Investing in International Markets: The Case for Global Diversification

International Market Investing in 2024

U.S. stocks have experienced impressive growth over the past 15 years, particularly when compared to equity markets in other regions. However, in the coming years, non-U.S. equities might start to play a more significant role in investors’ portfolios.

To understand how well U.S. stocks have done, think about this: in 2009, the S&P 500 Index was below 700 after a long period of poor performance compared to global stocks. Now, the S&P 500 has climbed to 5,000—over seven times higher than in 2009. Additionally, the average annual return of the S&P over this time frame has been consistently higher than those of other world markets.

This gap in performance can be traced back to the aftermath of the 2007–08 financial crisis. While other regions faced challenges, the U.S. swiftly recovered, thanks to significant government support. Companies and consumers strengthened their financial positions, and a surge in nonbank funding, especially from venture capital and private equity, fueled a boom in tech innovation. Then, the pandemic hit, followed by the 2023 regional bank crisis, prompting even more stimulus.

Throughout these events, U.S. stocks continued to thrive. Today, they make up a remarkable 63% of the MSCI ACWI benchmark's market value, despite the U.S. accounting for around 25% of global GDP. This dominance of U.S. stocks might lead global investors to believe there are no other attractive options. However, there is an increasingly significant rationale to consider international stocks in portfolios where, on average, most investors hold less than 10%.

Rationale for International Investing

Considering the high valuations of U.S. stocks today, investing in non-U.S. stocks could be a wise strategy to protect your portfolio in case of a potential downturn in the U.S. market. Such a scenario is conceivable as U.S. policymakers contemplate scaling back their extraordinary economic support amidst stable growth, inflation, and employment trends. Currently, there are significant gaps between U.S. and non-U.S. stocks in two key areas:

1. Valuations: On average, S&P 500 stocks have a forward price-to-earnings ratio of over 20, compared to about 13 for the MSCI All Country World Index (ACWI) excluding the USA. This suggests that non-U.S. equities appear relatively inexpensive compared to their more expensive U.S. counterparts. In short, international stock is cheaper.
2. Dividends: Stocks in the non-U.S. index offer an average dividend yield of 3%, which is more than double that of the U.S. index's stocks and this may appeal to income-seeking investors.

Case Study: Japan

The best-performing market (at the time of writing) in local currency terms this year is Japan.?

After decades of virtual stagnation, Japan has seemingly turned a corner, offering a range of opportunities driven by several key factors:

1. Corporate Changes Since earlier this year, there's been a big push for corporate reform, with regulators revealing that 54% of companies are working on plans to lower costs and improve their value. These efforts are expected to bring out hidden value in Japanese stocks. There's also been a surge in private equity deals and share buybacks, with over 1,000 companies announcing buybacks in 2023, two years in a row. More companies are splitting shares, making it easier for regular investors to join the stock market.
2. Foreign Interest: From Warren Buffett's Berkshire Hathaway in 2019 to Chinese retail investors now, there's been a lot of interest in Japanese stocks. At the end of 2023, foreign investors held $100 billion more in Japanese stocks than they did ten years ago, while still leaving room for more global investment in Japan's revamped companies.
3. Diverse Market and Quality: Japan's market has the second-largest daily trading volume in Asia after China's onshore market, even surpassing Hong Kong. Its depth and variety could attract more international funds, possibly narrowing the gap with top Chinese exchanges. Additionally, investors can find quality companies in Japan with global reach.
4. Tourist Appeal: Japan's tourism is almost back to pre-pandemic levels, with nearly 2.7 million visitors in January of this year. More international flights and a temporarily weaker currency are making Japan trips more affordable. There's also been a rise in visitors from the U.S., Europe, Australia, and the Middle East, offsetting the drop in Chinese tourists.
5. Geopolitical Advantage: Japan seems to be in a good spot amid the ongoing tension between the U.S. and China. Japanese companies often lead in their industries and are sought after by both China and the U.S.

Key Regions and Opportunities Beyond Japan

Europe: The European Central Bank's monetary easing, increased defense spending due to geopolitical tensions, and investments in AI and decarbonization are likely to spur economic growth and investment opportunities.

Emerging Markets: Despite challenges in China, other emerging markets like Brazil, India, Vietnam, and Mexico are poised for growth due to favorable fiscal policies, political stability, and efforts to reorganize global supply chains.

Conclusion

While the U.S. market remains a powerhouse, it’s worth recognizing the significant differences in value between U.S. and non-U.S. stocks. Additionally, there's growing potential for growth in other parts of the world like Japan, Europe, and emerging markets. We should also keep an eye on concerns like political issues in the U.S. and the increasing levels of national debt. If these factors prompt foreign investors to adjust their portfolios towards their own domestic markets, it could lead to volatility in the U.S. market.

Sources:

Empower, Bloomberg, MSCI, Morgan Stanley, Julius Baer

Disclosure: Data presented as of June 10, 2024. Information and references to specific investments or indices are for illustrative purposes only and are subject to change without notice. It is not intended as investment and/or financial advice and should not be construed as an offer or solicitation to buy or sell any security or asset class. It should not be assumed that Morton will make investment recommendations in the future that are consistent with the views expressed herein. The investments discussed may fluctuate in price or value. All investments involve risk, including the loss of principal. Past performance is no guarantee of future results. You should consult with your financial advisor to thoroughly review all information before implementing any transactions and/or strategies concerning your finances. Although the information contained herein is from sources deemed to be reliable, Morton Wealth makes no representation as to the adequacy, accuracy or completeness of such information and it has accepted the information without further verification.

Index Definitions:

The S&P 500 Index is?a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is regarded as one of the best gauges of prominent American equities' performance.

The MSCI All Country?World Index?(ACWI) is?a stock index designed to track broad global equity-market performance. Maintained by Morgan Stanley Capital International (MSCI), the index comprises the stocks of nearly 3,000 companies from 23 developed countries and 24 emerging markets as of Dec. 29, 2023.

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