Investments

Is investing in foreign stocks a good idea? – MarketWatch

Summary

How many years of underperformance must you endure before you’re justified in giving up on international stocks?

Many of you are wondering since, contrary to endless recommendations from retirement financial planners to be internationally diversified, U.S. equities continue to outperform. This year it is not even close: The S&P 500’s
SPX,
-2.27%
year-to-date return is 26.3%, versus just 11.0% for MSCI’s Europe, Australasia and Fa…….

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How many years of underperformance must you endure before you’re justified in giving up on international stocks?

Many of you are wondering since, contrary to endless recommendations from retirement financial planners to be internationally diversified, U.S. equities continue to outperform. This year it is not even close: The S&P 500’s
SPX,
-2.27%
year-to-date return is 26.3%, versus just 11.0% for MSCI’s Europe, Australasia and Far East Index (as measured by the iShares MSCI EAFE ETF
EFA,
-2.69%
).

This year is hardly the exception, however. Over the last decade the S&P 500 has doubled the annualized return of the iShares MSCI EAFE ETF, 17.2% to 8.6%. And over the last 15 years, the S&P 500’s annualized return is nearly three times larger, 10.5% to 3.7%.

For this column I am reviewing, once again, the case for international diversification, looking to see if anything has changed that would require altering the traditional financial planning advice.

Diversification

One of the primary reasons why international diversification is recommended is its ability to reduce portfolio volatility. As modern portfolio theory teaches us, to the extent non-U.S. stocks are uncorrelated with U.S. equities, an equity portfolio divided between the two will be less volatile than a portfolio that invests in U.S. stocks alone.

There’s an Achilles’ heel in this argument, however: U.S. and international stocks are least correlated during bull markets, and they become highly correlated during bear markets and crashes. These features greatly reduce the benefits of international diversification, since it would be better if just the opposite were the case.

That’s because we don’t really want diversification when the U.S. market is rising. We instead need it when the U.S. market is declining, and yet that is precisely when the correlation between U.S. and international stocks is highest.

This is illustrated in the accompanying chart, which plots the correlation of monthly returns over the trailing five years of the S&P 500 and the EAFE ETF. Notice that the correlations jump during bear markets.

As an example, consider the stock market’s waterfall decline in February and March of last year, when the COVID-19 pandemic led to a wholesale shutdown of world economies. For the month of February, the S&P 500 lost 8.1% while the EAFE index lost 8.2%. In March, both lost 12.4%. So in those two months international diversification produced no benefits.

Notice also that the correlation between the two markets is much higher today than it was in the 1990s. This is relevant because the traditional case for international diversification is in large part based on historical results from long-ago decades. If correlations are consistently higher today than before, then that’s another reason why the traditional rationale needs to be …….

Source: https://www.marketwatch.com/story/is-investing-in-foreign-stocks-a-good-idea-11637941887