Don’t Forget International Stocks

Nikkei 225

Nikkei 225 Index price ended 30 years roughly flat, from 1990 to 2020

People who grow up in countries outside the US and who have an appreciable net worth rarely make this same choice. They hedge their risks by owning non-domestic assets, stocks, real estate and currencies. Wealthy Mexican nationals who lived through the 1982 banking crisis or the 1994 currency crisis wouldn’t dream of owning only Mexican assets denominated in Mexican pesos. Wealthy Brits who lived through the pound devaluation in 1992 feel the same way. Or wealthy Russians during the 1998 devaluation. Same with anyone who grew up anywhere in Latin America at any time in the last one hundred years. You get the idea.

Lots of easy caveats and corrections may be applied to this theory of international diversification I’ve presented. One, for example, is that many US multinational companies provide exposure to developed and emerging market economies, so that a US-based portfolio still has quite a bit of global exposure embedded in it. Ok, sure, I partly agree.

Another argument is that a strong tradition of rule of law and regulatory protection makes US-investing inherently superior to non-US investing, for now and for the foreseeable future. I don’t disagree with the initial observation, but I would argue that prices, market capitalization, and future returns will efficiently reflect those institutional differences, over time. Including, especially, in the future.

At the risk of being accused of unpatriotic thoughts, I would also argue that US exceptionalism was real in the past, may still mean something in the present, but isn’t something I would permanently bank on for the future. The main point of portfolio theory investing is that we don’t know what will happen in the future. We can’t control the future, but we can manage our risk and return – as close to the efficient frontier as possible – through diversification.

Another key caveat is that international stocks have become more correlated with US stocks over the past few decades, so we achieve less non-correlation in recent years than we would want from non-US investing. That’s not a reason to not diversify, but rather, a reason to stay vigilant about correlations.

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