Why now is just the time for more international investments

If performance is the scoresheet by which markets are measured, U.S. stocks have won a lot more than international equities in the past decade. An “America First” portfolio of S&P 500 large-cap stocks posted better returns than a broad basket of foreign stocks in eight of the past 10 years.

That lost decade for international stocks, measured by the MSCI World ex USA Index, has put the principle of foreign portfolio diversification under the spotlight. It’s prompting some clients to ask their financial advisers if allocating investment dollars overseas is even worth it. And it’s compelling many wealth managers to make the case on why staying invested in non-U.S. stocks still makes sense.

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Client frustration and pushback are not lost on financial advisers, whose job it is to optimize returns while also managing risk.

“We try to educate them as best we can,” said Brad Bernstein, managing director and senior portfolio manager at Bernstein Wealth Management, a UBS affiliate in Philadelphia. “We show them the facts, the data and the history that validate our opinion.”

His current message to clients? Look to the future, not the past.

“Right now, the U.S. market is the best house on the street,” Mr. Bernstein said. “But I think there is opportunity on the other side of the street.”

Now, after a decade of underperformance of foreign shares compared with U.S. stocks, is not the time for U.S. investors to be second-guessing international diversification.

Nor should they be giving up on foreign stock investing, especially since history shows U.S. shares don’t always sit atop the world’s performance standings. In the 2000s, a decade marred by the dot-com stock bust and Great Recession, U.S. stocks posted negative annualized returns. In contrast, international stocks that decade posted positive returns and better relative performance, with emerging markets stocks outpacing U.S. stocks by more than 10 percentage points on an annualized basis, according to iShares data.

“When looking for investment opportunities, we try to go where the puck is going to be, not where it’s been,” Mr. Bernstein said, using an analogy from hockey great Wayne Gretzky.

The U.S. won’t always be the place with the biggest gains, so it’s important to be exposed to foreign stock markets to capture gains when returns overseas retake the lead.

And a shift in market leadership could be nearing as the 2020s get underway, according to Vanguard. In its 2020 outlook, the fund giant upgraded its global equity outlook over the next decade. It expects global non-U.S. stocks to post annualized returns of 6.5% to 8.5%, compared with anticipated gains of 3.5% to 5.5% for U.S. stocks. Vanguard cited “more reasonable valuations” as the key reason for their bullish call on foreign stocks.

Like Vanguard, financial firms with large armies of financial advisers, such as Edward Jones, which touts 18,500 advisers, and UBS, also are bullish on international stocks relative to U.S. shares.

“We are overweight international equities relative to U.S. large caps,” said Nela Richardson, investment strategist at Edward Jones. The bullish big-picture call favoring foreign stocks is based on cheaper valuations overseas, expectations for a global growth rebound and a decline in the value of the U.S. dollar versus foreign currencies, she said.

But not all financial advisers are more upbeat on foreign stocks than they are domestic names.

Christian Thwaites, chief strategist at Brouwer & Janachowski in Mill Valley, Calif., said the firm’s been underweight foreign stocks for the past few years, and sees no reason to change tack now even though international stocks are less expensive. “I don’t think it is time to flip,” he said, noting his current foreign stock weighting is around 15% to 18%, compared to 30% when he’s wildly bullish on foreign equities.

Mr. Thwaites doesn’t think the growth rebound abroad will be as robust as some economists predict. He also disagrees with the notion that U.S. stocks are poised to underperform foreign stocks simply because they’ve had such a great run, especially with the U.S. economy on a predictable path and the U.S. Federal Reserve on hold. But he said his preference to stick with domestic stocks is a “minority” view.

InvestmentNews asked the handful of financial advisers who currently view foreign stocks in a more bullish light to make the case for sticking with international stocks. Here’s why some recommend staying the course:

Foreign stocks have cheaper valuations.

International developed stocks are trading at a 20% discount to the U.S. stock market, and emerging markets are selling at a 30% discount, Ms. Richardson said.

Outlook for global growth is stronger.

Global growth is expected to strengthen to a 3.3% pace in 2020 and 3.4% next year, up from 2.9% in 2019, according to the International Monetary Fund. That’s better than U.S. growth, which is expected to slow from 2.3% in 2019 to 2.0% this year and 1.7% in 2021. The IMF forecasts even peppier growth this year in emerging markets, predicting 4.4% growth; and in emerging Asia, which is seen growing 5.8%. "We expect global growth to rebound," Ms. Richardson said.

U.S. outperformance not likely to persist.

Market cycles tend to be prolonged when it comes to either U.S. or international stocks doing better than the other. Market leadership can last a decade. U.S. stocks, for example, bested foreign shares handily in the 1990s. International and emerging markets equities, however, posted better returns than the U.S. in the 2000s. And U.S. stocks trounced international stocks again from 2010 to 2019, iShares data show. In other words, history says, international shares are poised to play catch-up.

Staying invested in foreign stocks or boosting your overseas stock allocation before these lagging non-U.S. markets eventually rebound, could prove profitable.

“You’re definitely going to want to be invested in foreign markets when they turn — and they will turn,” said David Gottlieb, a financial adviser at Edward Jones.

Lessening of trade strife to provide boost.

If the U.S. and China continue to dial back their trade dispute, or current tariffs are removed, “it would be a huge positive for global markets,” and China and emerging markets, in particular, as they have been hurt most by the trade war, Mr. Bernstein said.

All that said, even advisers turning more bullish on foreign stocks said they’re not recommending that investors exit the U.S. market in a massive allocation shift. Rather, they are simply advising that U.S.-centric investors funnel some of the gains made in U.S. stocks in the current bull market and tilt portfolios more toward overseas stocks through diversified investments in foreign mutual funds, ETFs or individual foreign stocks that trade on American stock exchanges.

“We’re not talking about taking all your money out of the U.S. equity market; we’re not saying sell all your Apple today,” Mr. Bernstein said. “We’re talking about taking a small portion and (investing it overseas) in an effort to get better returns. Do it in a measured pace. Rule No. 1 of diversification is you can’t only invest in your own country. More than ever now, as a firm, we like international.”