It’s a Big World After All

It's a big world, folks-own it! Photo by Buyenlarge/Getty Images.

New research says international investors own more US stocks than ever. America outperformed all but one developed-world market last year. A certain index-fund guru says he "wouldn't invest outside the US." US economic growth is leading the developed world. Perhaps this has you wondering: Should I forget foreign and own US stocks only? But tempting as that might be, we think it's unwise. Diversification matters, and leadership flip-flops.

Some see America's higher cumulative longer-term performance and suggest US stocks are superior. However, this is skewed by the recent past. As Exhibit 1 shows, US and foreign returns were basically equal as of September 2011 (circled). In 2006 and 2007, many thought foreign markets (and particularly Emerging Markets) were perma-best. Foreign stocks had higher cumulative returns through much of the US-dominated 1990s bull. Trends don't last forever.

Exhibit 1: US Vs. Foreign Since 1970

Source: FactSet, as of 1/12/2015. S&P 500 Total Return Index and MSCI EAFE Index with net dividends, 12/31/1969 - 12/31/2014. Circle indicates last point of zero difference in cumulative return.

Exhibit 2 shows flip-flopping leadership a different way-the difference between US and foreign returns annually since 1970. America led in 20 of 45 years-essentially a coin flip.

Exhibit 2: US Vs. Foreign Stock Performance by Calendar Year

Source: FactSet, as of 1/7/2015. MSCI USA and MSCI EAFE indexes, inclusive of dividends (and net of withholding taxes for the MSCI EAFE), 12/31/1969 - 12/31/2014.

Even when the US outperforms foreign stocks overall, that doesn't mean America beats every country, as Exhibit 3 shows. The US has never been the MSCI World Index's top-performing country! Now, take that with a grain of salt, as some countries have far fewer companies. Last year, for example, Israel was tops-but the MSCI Israel has nine companies and 70% of its market capitalization is Teva Pharmaceuticals.^[i] But bigger countries frequently lead, too, and the US is often in the middle of the pack. Not inherently inferior! But US outperformance doesn't mean other countries lack opportunities.

Exhibit 3: America Has Never Been First

Source: FactSet, as of 1/12/2015. Annual returns for every country in the MSCI World Index, inclusive of dividends (and net of withholding taxes for non-US indexes), 12/31/1969 - 12/31/2014.

Still not convinced? The final 10 charts show 10-year trailing returns for the MSCI World Index's current 24 constituents as of year-end in each of the last 10 years. From 2005 - 2014, the US was fifth-best. But from 1998 - 2007, America was third from last.

Exclude non-US stocks, and you exclude every opportunity outside America-a huge blind spot. Diverse as our economy is, sometimes trends just favor other countries. Ditto for political drivers. What if Hong Kong gets a boost from Chinese reform? What if regulatory clarity boosts Britain? What if eurozone sentiment improves? A global portfolio also helps you limit risk. What if gridlock went away here? What if growth badly missed expectations? Investing globally is the answer to all these what-ifs.

It's always tempting to chase heat, especially as maturing bull markets grind higher. And particularly when it might be your home country! But diversification is always vital, and a US-only portfolio isn't as diverse as a global one. It might give you exposure to every sector, but it would ignore about half the world's market cap and wouldn't diversify any of its political or legislative risk.^[ii] Limiting yourself simply because America has done great lately is a fool's errand.

Exhibit 4: The Evolution of 10-Year Trailing Returns, by Country

Source: FactSet, as of 1/12/2015. 10-year trailing returns for every country in the MSCI World Index, inclusive of dividends (and net of withholding taxes for non-US indexes), as of year-end, for the years 2005 - 2014.