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Investing internationally has become a standard method of diversifying the return streams of an investment portfolio. Rather than being subject merely to performance of the domestic markets, such as the S&P 500 or Dow, diversifying internationally is supposed to provide investors with a smoother stream of returns over time. However, recently investors have a growing disdain for foreign stock markets as US stocks plow ahead.
The Case for International Holdings
Historically, international investments have not performed on par with the S&P 500—up 4.5% versus 6.5% for the US in real terms.[i] However, the correlation between the two will generally provide a reduction in ongoing volatility of a portfolio. In addition, foreign markets do not always underperform their domestic counterparts as the chart below illustrates.
Lastly, because I like splitting hairs, there were 583 total monthly return observations in my dataset. Of those, 294 showed international markets outperforming domestic markets while 289 showed the opposite. And very lastly, looking at the magnitude of the “winning” months, international averaged 13.95% relative performance in winning months vs 14.33% relative performance for the S&P 500 during its winning months.
What’s the Point?
The idea that international investments will never help your portfolio because of recent weakness, that you can time when the market cycle will change to favor international stocks, etc. is nonsense. Remember, you aren’t properly diversified if there isn’t something you hate in your portfolio all the time. I also enjoyed this chart that Dan Egan posted on his Twitter account:
We are experiencing a drawn-out period of international weakness, and currency movements haven’t helped.
The movement of foreign currencies to the US dollar (USD) can impact your total return through translation gains/losses. A simple example may help. Assume you invest USD $1,000 in a British company when the currency rate is $1/£1 so you have GBP £1,000. The investment was a success and increased in value by 10% over your holding period to GBP £1,100. If, at the same time, the USD got stronger relative to the British Pound by 10%, your actual return is 0%. That is a 10% gain in the investment and a 10% loss from the currency.
Over the last few years, 2017 being the exception, the US dollar has strengthened relative to foreign currencies, which is a headwind to international investments. The following chart shows the returns of the “World” index in USD (after accounting for currency changes), the “World” index in local currencies (before accounting for currency changes), and the USA.[iv]
The key takeaway is two-fold: 1) the international markets have not been performing on par with the USA, as evidenced by the orange column versus the gray, and 2) aside from 2017, the currency adjusted returns are worse than local currency returns. The second issue illustrates that the dollar has been getting stronger, creating an additional hurdle for international investments.
As noted above, 2017 was an exception as the dollar weakened relative to foreign currencies. However, 2018 has been quite a different story as most foreign currencies have taken a dive! The following table is from Bloomberg (as of 9/19/2018) and shows the year-to-date currency changes versus the US dollar. The countries are grouped by geographical area or style; for example, Brazil, Russia, India, and China are the major emerging market countries while Europe, Britain, Switzerland, and Denmark can be thought of as Europe. I also wanted to include Turkey since it has been in the news recently as well as Venezuela, which has fallen upon difficult times.
An investment in the Brazilian index would show a small negative return in the Brazilian Real, but the Real has fallen from around USD $0.30 to $0.25, pushing a US investor’s return down near 20% for 2018. Surprisingly, the Mexican Peso and the Japanese Yen have strengthened slightly to the dollar this year.
Typically, the only data that matters and the only data really presented, is a US investor’s total return from an investment. This wraps the actual investment return and currency return together, sometimes hiding factors at work boosting or hindering performance. We believe it is important to keep perspective about what is pushing different markets ahead or pulling them down. International countries have been slow to right their economies in the aftermath of 2008, but improvements have been made as foreign developed economies continue to strengthen.[v] Currencies will continue to ebb and flow over time but the trade wars and tariff negotiations will settle out providing a needed boost to international investments.
[i] Credit Suisse Global Investment Returns Yearbook 2018 - Page 11 “The real return on US equities of 6.5% contrasts with the real USD return of 4.5% on the World-ex USA index.”
[ii] Historical price data from Yahoo! Finance
[iii] Historical return data from MSCI’s website
[iv] All data from MSCI’s website
[v] World and country specific GDP growth per The World Bank
Bryan Strike, MS, MTx, CFP®, CFA, CPA, PFS, CIPM is a Senior Financial Advisor at Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at firstname.lastname@example.org.
This report and Mr. Strikes’ comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance.
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