Why International Diversification Matters Today (Part 3 of 6)
While three months of relative performance shouldn’t change anyone’s long-term asset allocation, recent events are a useful reminder that U.S. outperformance isn’t pre-ordained and that it’s important to consider having exposure to international stocks. In fact, as I write in my new Market Perspectives paper, “Innocents Abroad: The Case for International Diversification,” there are three reasons why international diversification matters now more than ever for U.S. investors.
Market Realist –
Consider investing in Europe and Japan.
The S&P 500 outperformed both Europe and Japan in 2014, with returns of 11.4%, 4.1%, and 7.6%, respectively. The US economy was on a strong footing, while both Europe and Japan saw deflationary pressures.
This year, however, has seen the opposite take place. The graph above compares the performance of the MSCI Europe Index (IEV) with the MSCI Japan Index (EWJ) for 2015. The returns for the two are 19.0% and 15.1%, respectively, compared to 3.0% of the S&P 500 (SPY).
This outperformance is mainly due to two reasons. QE (quantitative easing) in both Europe and Japan has lifted both countries’ stock markets. The weaker euro and yen have also made their exports attractive to Americans. The reasons for the underperformance of the S&P 500 were discussed in the previous part.
Europe (FEZ) is seeing green shoots of growth. One cause of the turnaround in the economy is the weakness of the euro, as we already saw. Another cause is that the price of crude oil (USO) has fallen, cutting energy costs of firms and improving consumers’ purchasing power. Meanwhile, the QE program is pushing already low borrowing rates even lower, causing credit conditions to ease. Business and consumer confidence is also turning around, and business activity is increasing.
European and Japanese stocks will continue to outperform the American ones in 2015, given their more attractive valuations and Japan’s more market-friendly central bank policies. Also, Japan’s Pension Fund is increasing its allocation to equities, which would be a tailwind to Japanese equities.
Browse this series on Market Realist: