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Does Your Portfolio Need a Passport?

Woman on tablet device in airport terminal

Political risks are rising around the world, but we think savvy investors can benefit by looking beyond the worries and adding international equity investments as a portion of their well-diversified portfolios.

Look at more than headlines

Today’s headlines range from quite severe – such as North Korea’s belligerence, terrorist attacks and Middle East military conflicts – to modestly disruptive, including European elections and Brexit (the British exit from the European Union). That long list of concerns may make it difficult to see the signs of better global economic growth and brighter prospects in many countries.

Synchronized global rebound

After several disappointing years, world economic growth is accelerating:

  • The Organisation for Economic Co-operation and Development expects global economic growth to improve to 3.3% in 2017 and 3.4% in 2018.
  • Manufacturing has picked up worldwide since mid-2016.
  • Concerns about deflation in Europe and Japan have diminished as prices have started to rise, although inflation rates remain quite low.
  • Expansionary policies continue, including higher government spending and asset purchases by the European Central Bank and the Bank of Japan.
  • Emerging markets, led by China, continue to grow more quickly than developed economies.

Since the end of the financial crisis in 2009, global growth occasionally started to accelerate but then faltered. This time, however, recent indicators have continued to improve, a bright sign for future economic growth.

Can international stocks continue to outperform?

Between 2000 and 2014, international developed-market stocks and U.S. large-cap stocks tracked each other fairly closely, as the chart shows. But in four of the past five years, international stocks lagged and fell behind. Performance leadership has rotated in the past, and international equities outperformed following past times when they’ve lagged. That rotation may have started in the first quarter of 2017, when returns on international developed-market stocks were 7.2%, exceeding the 6.1% return on the S&P 500.

Is the tide turning?

International Stocks Outperformed U.S. Stocks in the First Quarter of 2017

tide-turning-chart

Source: Morningstar Direct, 4/30/2017. U.S. Large-cap Stocks represented by the S&P 500 Index. International Developed-market Stocks represented by the MSCI EAFE NR Index. Indexes are unmanaged and are not available for direct investment. Past performance is not a guarantee of future results.

Why consider international stocks?

In addition to the first quarter’s better performance, we think international developed-market stocks continue to look more attractive than U.S. large-cap stocks due to their:

  • Higher dividend yields
  • Better expected earnings growth rates
  • Lower valuations based on price-to-earnings ratios

These better fundamentals also support our expectations for higher long-term rates of return on international equity investments. As a result, we recommend adding international equity investments if appropriate. 

We think the opportunities are more attractive in developed markets than emerging-market equity investments but recommend owning both. Keep in mind, there are special risks inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

A clearer view of the future

Near-term forecasts tend to be wrong, and the future rarely looks like the recent past. That’s especially important when comparing Europe and the U.S., since Europe recovered from the Great Recession much more slowly than the U.S. Some investors may not be considering attractive global opportunities due to Europe’s very prolonged, halting recovery; slow Japanese growth; and recent political headlines.

Adding international equity investments to your portfolio can help you stay prepared for a wide variety of possibilities. And they can increase the chances of positive returns over time because they don’t always move in lockstep with U.S. investments. For a clearer view of the future, keep a long-term perspective – longer-term trends can be easier to spot than short-term moves. And broaden your investment horizon by adding international equity investments that are appropriate for your goals and look well-positioned to benefit from an improving world.

Important information:

Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal.

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