About to Buy THE S&P 500? HERE ARE 8 CHARTS ON WHAT YOU MAY MISS
As portfolio managers, we are constantly reminded of changes in the world’s economy.
Yet, our minds tend to resist change.
Especially, when we have an emotional attachment to a country.
Over the past 20 years, I visited most of the U.S. States. I spent time at NYU and joined a prestigious Wall Street Graduate Programme in the late 2000s. I was impressed by Silicon Valley.
But while cycling the world I was confronted with realities that I previously underestimated.
This century may not belong to America. And my portfolio needed to reflect it.
Here are risks and opportunity costs to consider by concentrating your investments.
Even in the strongest country, like the U.S.
And reasons why you should also embrace international diversification.
WHY A FTSE ALL-WORLD OR MSCI ACWI ETF MAY BE PREFERABLE TO S&P 500 IN 8 CHARTS
#1 BENEFIT FROM THE NEXT LEAP
Let’s start with one of the biggest misconceptions today – the U.S. Outperformance.
Over the past 50 years, the U.S. Market has outperformed the rest of the world by a whooping margin of 1% per year.
The S&P 500 returned on average 9.8% vs. 8.7% for International Markets (ex-US). Even more impressive is the fact that the Index outperformed with lower volatility of 15.2% vs. 17% for International Markets.
A win-win? Well, not quite.
Guess, how much of the 50-year outperformance came in the last 8 years?
All of it. History doesn’t crawl. It leaps.
Until 2014, the average annual performance was nearly 9.6%, for both Markets.
If history is a guide, it is a matter of when, not if, International Stock will catch up again.
#2 BET ON ASIA (TECH)
There are at least two reasons why with Emerging Markets you want to have skin in the game.
First, while the downside is limited, your upside may be asymmetric.
Did you know that today Chinese Stocks have almost no impact on the performance of a Global Equity ETF?
In fact, their entire allocation weighs less than that of Microsoft.
Combined, Emerging Markets Stocks only represent 10% of a Global ETF.
That’s because of various screens applied by Index providers, due to market segments being difficult to access. Without them, EMs should stand at 26%.
Yet, today, six out of ten people live in EMs. They account for over 50% of global GDP. By 2025 they may capture 70% of global growth. Partly through Tech.
Most investors know how Tech dominates the S&P 500. What’s less known, is that Asian Tech is rising to the same proportion of EM Indices.
- IT and Communication firms including Samsung, Taiwan Semiconductors, Tencent or Indian Infosys account for over 30% of EM’s Market Cap.
- By adding E-commerce platforms, like Alibaba or JD.com, that make up most of Consumer Discretionary sector investors capture 46% of EM Equities.
Evolution of Emerging Markets Sector Composition
Second, US corporations predominately focus on their domestic market (see #7). While cycling in Asia, I noticed some challenges that lay ahead.
US Tech companies have little to no access to certain markets. And some super apps like Tencent’s Wechat or Line are much more powerful than Western apps.
#3 DILUTE CURRENT HYPE
Valuations differ across countries and sectors
Now, let’s talk about various risks.
By investing globally, nearly a third is allocated to the ‘old Economy’.
Yes, by many growth measures, Europe and Japan lag. Their heavyweights mainly include Financial or Industrial companies.
Not very glamorous. But relatively cheap.
Remember that you can either have high prices or high future returns, not both. The price you pay matters.
In Dec’21, the CAPE for the US Market stood at 39 (currently 32, as per the map), an expensive level by historical standards. For the UK, it stood at a modest 17.5. Over the next 8 months, the S&P 500 lost over 20% while the FTSE 100 remained roughly flat. Some market participants, including Vanguard, saw it coming. But perhaps not as quickly.
CAPE has its flaws. For example, valuations can’t be relied upon in the short term.
But investing globally often means lowering the purchase price by diluting currently overhyped sectors or countries.
#4 INCREASE THE LIKELIHOOD OF FINANCING YOUR GOALS
Annual Volatility For Global Portfolio and Select Markets
By avoiding hype, you may sleep tight.
But there is also another, very practical reason, why you may be more confident of reaching your objectives by investing globally.
Over the past 50 years, holding a global portfolio also reduced volatility compared to the S&P 500.
Make no mistake, other countries fared far worse. If you limited your portfolio to European or certain Asian Markets volatilities were from 15% (Switzerland) to 100% (Hong Kong) greater than the global index, according to Vanguard.
But diversifying globally reduces the uncertainty of financing your investment goals, especially if they are medium-term.
#5 HEDGE AGAINST U.S. UNDERPERFORMANCE
Performance measured as share of Global Stock Market
There are reasons why the U.S. Stocks increased their relative share from 25% of the Global Stock Market in 1990 to 60% in 2020.
U.S. Corporations are incredible growth engines, powered by technological edge, global exposure, pragmatical thinking and strong governance. The rule of law, solid institutions and the US Dollar make America a unique place to invest.
Yet today’s America is like a comet. Its nucleus is more powerful than ever. But the dust tail has a hard time following and becomes more visible.
After having cycled Asia and crossed the Pacific I came to realize that the main challenges the U.S. faces are not external, but internal.
Here are just a few that strike cyclists on the West Coast:
- Parts of America are left behind like the comet’s dust. An impossible catch-up game as inequalities are growing.
- Internal conflicts are rising. Whether measured by protests or political drifts.
- Healthcare is inefficient. Lack of social safety net makes scandals that kill hundreds of thousands of people and leave millions addicted, possible.
#6 GET A RECOVERY INSURANCE
Individual Markets may experience catastrophic losses
Global investing also reduces an even more important risk.
The risk of permanently losing your capital.
Yes, from that perspective the U.S. is arguably the strongest country. This one is less about America and more about country concentration risk in general.
In the past century, there have been many times when investors saw their wealth wiped out by geopolitical upheavals, debt crises, monetary reforms, or the bursting of bubbles, while markets in other countries remained resilient.
#7 LOOK BEYOND HIGH CORRELATIONS
Today Companies Sell Products globally
With globalization, it doesn’t matter where a stock trades but where it makes money. For example, the pharmaceutical firm GlaxoSmithKline from UK’s FTSE 100 Index has minimal revenue exposure to the UK.
It sells globally. And will be highly correlated to other markets. As do other UK firms that derive 78% of revenues from abroad.
So, why wouldn’t you keep it simple and only invest in the S&P 500 since correlations with other markets are high?
The key aspect to understand is that diversification is more than correlation.
Diversification is also about the magnitude of price moves.
And magnitude can translate into excess returns.
For example, certain European or Japanese companies’ revenues are very local. These tend to be the same small-cap value stocks that are documented to capture excess long-term returns for investors.
#8 DARE TO DISAGREE WITH BUFFETT AND BOGLE
Upon his passing, Warren Buffett directed the trustee for his wife’s benefit to “put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
Don’t look for the needle in a haystack. Buy the Haystack.
If you follow Buffett and Bogle’s advice, chances are you will end up wealthy. Why?
Because the behavioural aspects, low fees, and broad-enough diversification, that both preach will determine most of your success.
They are more important than the S&P 500 vs. World Index debate.
But since you are reading this website, chances are you have an above-average investing acumen. You can use academic research that expands on Buffett & Bogle’s diversification principle and take it a step further.
Don’t try to pick the winning country. Buy them all.
More important than the S&P 500 vs. Global Index debate is also sticking to your strategy.
It’s one of the reasons why active investing is difficult. Here are 8 other arguments for why active investing is more tricky than you think.
The choice is also not exclusive. You may decide to increase the allocation to the U.S. Market (vs. MSCI ACWI or FTSE All-World allocation) because you think current trends will continue for a while.
But if you’re like most of us, you may prefer sticking to a lazy Global Fund.
Thank you for reading and happy investing,
Explain It To A Golden Retriever – A Review Of World ETFs
What if you could only buy into ONE single investment for life? When you speak to people that have been in the investment business for long time (and that leaves short term speculation off the table) The answer often is… a World Equity ETF
HAVE A QUESTION ABOUT INVESTING? ASK US.
SHARE THE ARTICLE
REACH FINANCIAL INDEPENDENCE EARLIER
All information found here, including any ideas, opinions, views, predictions expressed or implied herein, are for informational, entertainment or educational purposes only and do not constitute financial advice. Consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate. Read our full terms and conditions.