Lost amid all the talk of the "Trump bump" on Wall Street is the fact that U.S. equities, while up, have actually been among the worst performers in the world this year. Stock markets in Mexico, China, Spain, France, Brazil, South Korea, Singapore, Poland, India and Turkey have not only outpaced the S&P 500 U.S. index so far in 2017, they've more than doubled the gains of domestic shares.
Setting the politics of globalization aside, the resurgence of foreign equities, which languished for several years in the aftermath of the 2007–09 financial crisis, comes at a critical juncture for retirement investors.
After the second longest bull market in history, U.S. stocks have become as frothy as they were in the run-up to the bursting of the dotcom bubble in 2000 and the Great Depression in 1929. This is based on the price-earnings ratio, or P/E, calculated using 10 years of averaged corporate profits.
Historically, the median P/E for the S&P 500 has been about 16. This year it has climbed above 29. "We have about the highest ratio in the world," says Robert Shiller, the Nobel Prize–winning Yale economist who popularized the use of this ratio, which many now refer to as the Shiller P/E.
Not only does this raise the risk of a downturn for U.S. stocks sometime in the near future (using this measure, Shiller correctly predicted the 2000–02 tech wreck, as he did the financial crisis), it points to the likelihood of disappointing returns over the next decade. Both outcomes would disproportionately affect the fortunes of older investors at or nearing retirement.
Foreign stocks, on the other hand, have lagged U.S. equities so much — they have fallen 18% over the past decade, while the S&P 500 has gained 60% — that they are among the few investments in this aging bull market that are actually considered cheap.
International equities in developed economies in Europe and Japan, for instance, are trading at a P/E of about 15, down from their historic norm of around 22. And the P/E for stocks based in emerging economies such as India and Russia is even lower — a mere 13. Among the cheapest emerging markets are those of China and Brazil, whose shares are trading at a Shiller P/E of 12 and 10, respectively. That's roughly 30% below their historic levels. Meanwhile, both China and Brazil have also been undertaking major economic reforms that have attracted global investors.
Research Affiliates forecasts that U.S. blue-chip stocks are likely to generate returns of less than 1% a year over the next decade, after subtracting out the effects of inflation. On the other hand, foreign stocks are generally expected to return more than 5% annually. And emerging-market shares are forecast to do even better: nearly 7% a year over the next decade.
Trouble is, rather than adding to their foreign stash lately, investors have actually been reducing their international exposure.
Today, the typical American investor age 35 to 50 keeps only 14% of his or her stock portfolio in overseas equities, according to a survey by Fidelity Investments. That's down from 18% in 2009.
Yet global equities make up more than 50% of the world's total stock-market capitalization. And a study by Vanguard found that the full diversification benefits of foreign stocks aren't achieved until one's portfolio reaches about 30% international exposure.
Retirement investors don't have to sell their domestic holdings to raise their foreign exposure. Investors could simply ratchet up the proportion of new contributions into their 401(k)s and IRAs that are earmarked for foreign stocks for the next several years.
The potential rewards of foreign exposure do not come without risks. If the U.S. were to slip into a bear market, foreign equities would likely fall too, at least in the short run. But based on their lower valuations, they would also be likely to bounce back quicker, money managers say. And while it is true that President Trump's threats to impose tariffs and renegotiate global trade deals add uncertainty, many overseas economies are several years behind the U.S. in their recoveries, meaning their economic rebound may have more years to go. "Why on earth would you want to only own the stocks of the economy that you live and work in?" says Ben Inker, head of the asset-allocation team at money manager GMO. "Owning a globally diversified portfolio opens you up for less risk of a really bad outcome in any single market."