Just as investors warmed to global investing, global stocks tanked. While the Standard & Poor's 500-stock index has fallen 40% through Dec. 12, the damage outside the U.S. has been worse—and in emerging markets, it has been devastating.
That convinced many investors that a basic argument for diversifying overseas, called decoupling, was no longer valid. Decoupling is the idea that foreign countries have large enough domestic economies that they are insulated from a financial shock or recession in the U.S. With that concept seemingly debunked, investors steered clear of foreign markets. Making matters worse for investors who had sent money overseas, currencies turned against them. In the boom years, a weakening dollar hiked returns when overseas investments held in Euros or rupees were sold and converted back to dollars. Until the Federal Reserve's latest rate cut and corresponding fall of the dollar, a strong dollar had done the opposite.
But there are good reasons to stay invested overseas. The U.S. represents less than half of global market capitalization, and many overseas countries (especially Brazil, India, and China) continue to grow at a faster rate than the U.S. Over the long term, adding foreign stocks decreases volatility and increases returns. So for those who want to add to foreign holdings, or want to get in for the first time, depressed equity prices (and today's relatively strong dollar) offer a chance to buy globally on the cheap. Finally, while markets tend to track each other more tightly when investors are afraid of their own shadows, as the global economy turns up, markets will reflect their individual strengths. Just because stocks in the U.S. and China, say, move in the same direction doesn't mean they're doing so at the same rate, with the same returns.
"While it's not the case that the U.S. is going to go through a painful recession and the rest of the world will go its merry way, other countries will hold up better," says Russ Koesterich, head of investment strategy at Barclays Global Investors in San Francisco. One hurdle for the U.S., he says: Consumers have too much debt. "Other countries, such as those in Asia, don't have those same imbalances. When this cyclical headwind starts to ease up, these longer-term imbalances won't hold them back as much." Koesterich says many U.S. investors should add exposure to foreign stocks: "Most have too high of a weight in the U.S. relative to global markets."
The percentage of your portfolio that should be overseas depends on your age and risk tolerance. Many advisers recommend 25% to 40%, with more going to developed markets in Europe and Asia and less going to emerging ones, such as China, India, Brazil, and Russia.
Jack Caffrey, equity strategist at J.P. Morgan Private Bank (JPM) in New York, is allocating 30% of equities to foreign stocks now, vs. a more typical 40%. Caffrey is a big believer in overseas investing for the long term. But in the short term, he argues, the aggressive approach the U.S. has taken to tackling its problems will lead it out of recession sooner than other countries, particularly those in Europe, where the response has been more sluggish. "We're more comfortable that a recovery will be relatively early in the U.S. vs. international markets," Caffrey says. "But at some point markets will become more certain, and you will start seeing assets moving to their own rhythms."
After all, those hurt the most by falling foreign markets are the ones who rushed in at the peak. Invest for the long term now, and, with luck, you'll ride the markets back up. "If you're really taking the long-term view, there is greater long-term growth outside the U.S. than in it," says Uri Landesman, head of global growth at ING Investment Management. "It probably won't be reflected in global equity prices for another year. But you'd better not give up on overseas, especially emerging markets, just because of what's gone on this year."
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