Our team maintains a positive outlook for global risk assets, including U.S. equities, but when we look at opportunities around the world, we believe it’s important for U.S. investors to revisit their asset allocation strategies to ensure they have adequate exposure to international and emerging markets, based on their risk tolerance and goals. In recent years, U.S. markets have been dominated by a highly concentrated group of growth stocks. We see signs that a far-reaching shift is underway in the global economy and markets, which sets investors up well for strategic global diversification.
For most of the past decade, a select group of U.S. large-cap growth stocks— Facebook, Apple, Amazon, Google, and Microsoft—have provided very strong and consistent returns. These are companies with strong fundamentals that have driven much of the returns they have provided. However, they have now become very large weights in the broad market. For example, these five stocks currently represent more than 20% of the S&P 500 Index.
It is not surprising that many investors and advisors question the need to diversify away from companies that have been consistent winners. It’s natural to ask, “What could go wrong?” In fact, we believe quite a lot could go wrong for investors who lack appropriate regional diversification.
While we believe U.S. economic conditions are moving in a direction that warrants cautious optimism, the current environment is very uncertain. The U.S. is facing a number of unknowns, including those related to the pandemic, as well as significant political risks as the presidential election approaches. There are still high levels of unemployment, and the roll off of some of the fiscal stimulus that has sustained households over recent months could create additional headwinds for the U.S. economy and markets.
Globally, massive fiscal and monetary stimulus have been very beneficial to global risk assets but have also increased correlations. In the medium term, we believe these policies have the potential to contribute to inflationary pressures, with supply chain disruptions and uncertain U.S.-China relations also adding to inflationary pressures. These are new risks that haven’t been present in U.S. equity markets for most of the past decade. It is likely these conditions could introduce a new investing regime where different factors and markets outperform. The recent weakness of the U.S. dollar, as well as strength in precious metals and non-US equity markets, all hint toward this regime change.
We believe the ingredients are in place for significant non-U.S. outperformance. Europe is moving toward a fiscal union, and COVID-19 recovery is tracking more uniformly across Asia and Europe than it is in the U.S. Additionally, valuations of non-U.S. equities remain attractive relative to the U.S. and versus historical levels, and as noted, the U.S. dollar is weakening.
One important tenet of successful long-term investing is to be positioned ahead of market turns. Data suggest that investors are holding above-average levels of cash. These high levels of cash, along with underweights to non-U.S. markets and consensus overweights to U.S. large cap growth stocks, could all lead to the ultimate pain trade once market participants rush to catch up with the turn to global market leadership we anticipate.
Over the past two months, we’ve seen Europe and the emerging markets leading global equity markets. Our global team believes this leadership has fundamental support given the political changes occurring in Europe and the economic recovery we see unfolding in Asia. As confidence in this global economic recovery builds, we expect these market leadership trends will remain in place.
Potentially more importantly for investors, if there is a U.S.-centered economic shock (which could be catalyzed by increased taxes, a new fiscal policy direction, or COVID-19), we could begin to see an even more pronounced divergence in returns. Well-diversified portfolios are likely to be much better positioned to weather such an environment.
And finally, from a bottom-up standpoint, there are some truly incredible businesses domiciled outside the U.S. that investors often ignore. (Our blog posts and “Global Insights” compendium takes a closer look at some of the powerful secular themes where non-U.S. companies are taking a leadership role.)
Global diversification may have fallen out of fashion in recent years, but we believe “home-country” bias will be increasingly disadvantageous for U.S. investors. Chasing performance is never a good approach, and we believe we are in a period that provides an excellent opportunity for investors to review their asset allocations to ensure they have the appropriate level of exposure to the long-term opportunities of the global economy.
Opinions are subject to change due to changes in the market, economic conditions or changes in the legal and/or regulatory environment and may not necessarily come to pass. This information is provided for informational purposes only and should not be considered tax, legal, or investment advice. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations and should not be deemed as a recommendation to buy or sell the securities mentioned.
Diversification and asset allocation do not guarantee a profit or protect against a loss.
As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.
The S&P 500 Index is considered generally representative of the U.S. stock market. Indexes are unmanaged, do not include fees or expenses and are not available for direct investment. Source for percentage of holdings in index: Bloomberg as of 7/27/20.
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