In recent years, investment advisers have been touting global diversification of stock market portfolios as a good way to obtain higher returns with lower risk. A new study by economists Campbell R. Harvey of Duke University and Claude B. Erb and Tadas E. Viskanta of First Chicago Investment Management Co., however, suggests that diversification can be a risky strategy.
The researchers analyzed the monthly performances in dollar terms ef 21 developed country stock markets, including Hong Kong and Singapore, from 1970 through 1994. To their surprise, they found that U.S. stock market declines were usually mirrored by declines in foreign markets (chart). Indeed, over the 25-year period, 18 of the foreign markets posted a negative average return for those months in which U.S. stock prices fell. The two exceptions were Japan, with no change on average, and Austria.
Similarly, the study found that average returns in all of the 21 markets (accounting for more than 90% of world equity capitalization) were lower during U.S. recessions than in expansions. In fact, in almost all cases, foreign markets were more highly correlated with U.S. stock movements during U.S. bear markets and recessions than during U.S. bull markets and expansions.
Available data for emerging stock markets indicate that many, but far from all, have done well during U.S. bear markets. But their performance is also more variable and in some cases seems to be reversing. "No market," says Harvey, "seems impervious to U.S. economic and stock market cycles."