Welcome Back Volatility (Part 5 of 6)

(Continued from Part 4)

An end to the bull market?

Not necessarily, but it does mean the structure of the bull market is changing, and it’s a good time to think about what geographies or sectors could lead the next leg of this bull market. International stocks are rising with the backing of quantitative easing programs, with European (EZU) and Japanese (EWJ) stocks up 18.4% and 9.1% year-to-date. In sharp contrast: U.S. stocks returned 2.3%. We think more moderate returns are likely in the cards for U.S. stocks this year, which makes a good case for international diversification.

Market Realist – The case for international diversification

A rise in volatility doesn’t necessarily mean that the six-year bull run is at an end. But there’s no denying the fact that the bull market is aging. As of May, the current bull run could become the third-longest run in the past eight decades. This has left investors wondering whether the rise is sustainable. With more turbulence on the horizon and currency headwinds putting pressure on corporate earnings, it makes sense to go global and adopt the case for international diversification (ACWI).

International stocks have done well in Q1 2015, primarily because of the central banks’ accommodative monetary policies. Both European (EWJ) and Japanese markets (EWJ) have been supported by mammoth quantitative easing programs launched by their respective central banks.

The previous graph shows the fund flows for US stock funds, international stock funds, and bond funds. US stocks (SPY) (VOO) actually notched outflows of $0.04 billion, while international stocks saw inflows worth $26.53 billion. Bonds (TLT) (BND) have also done well, with inflows of $36.75 billion. Soft global growth and the search for yield has veered investors toward global bond funds.

The above graph shows the total returns of US equity funds, international equity funds, and bond funds. International funds returned 4.5%. That’s higher than the 2.5% return from US equity funds. Bond funds notched up gains of 1.7%.

The case for international diversification indeed looks strong. Japanese equities are likely to get a thrust from the simulus program launched last year. The world’s largest pension fund, the Japanese Government Pension Investment Fund, has also increased its allocation of domestic equities from 12% to 25%. This could be another tailwind for Japanese stocks.

European stocks look good too on the basis of relative valuation, but be on the lookout for developments in Greece and the falling euro—both of which could prove to be headwinds and sources of volatility.