Do International Stocks Make Sense for Your Portfolio?

What would your answer be if I asked you whether U.S. stocks or international stocks had performed better in 2022? Surely it must be U.S. stocks; after all, isn’t that the best market to invest in? While 2022 was a challenging environment for investors in both stocks and bonds, international stocks outperformed relative to the U.S.  We believe owning international stocks can play an important role in a diversified stock portfolio, but the past decade has been tough. Given that global markets experienced several significant shocks, from Brexit to Europe’s sovereign debt crisis, the U.S. became the go-to market for many investors. The U.S. economy outperformed its counterparts , but the market environment may be primed for change. The economic climate is shifting as China has lifted its strict pandemic restrictions, and weather conditions in Europe led to a warmer-than-expected winter that put less pressure on energy budgets. When deciding whether to invest internationally, we like to look at the “3 Cs” as part of our evaluation process: country, company and currency.

Country

International stocks offer investors exposure to different geographies and economies. Stock markets outside of the U.S. comprise more than 50% of the global equity market, and we believe it would be wise for many investors to consider them as part of a well-diversified portfolio.  Markets in different countries may look drastically different, each with various distinct risks affecting returns for investors. Important characteristics we suggest reviewing before investing in a specific country include levels of imports and exports, the demographics of its population, the geopolitical climate, the strength of that country’s currency and its growth prospects. These are just some of the factors we consider, so doing your homework before investing is important.

We believe there are a few geographies that look relatively attractive today. Leading up to 2023, China’s economy was essentially shut down for three years as a result of the pandemic, and this had a significant impact on global economic growth. However, the announcement of an earlier-than-expected and more rapid reopening in China could serve as an inflection point for the global economy. As mentioned, the likelihood of a recession in Europe has decreased because of a warmer-than-expected winter and positive economic surprises.  European stocks have responded positively, while we believe demand from Chinese consumers and Beijing’s supportive policy should provide an additional boost.

Company

There can be some key differences between the types of companies in the U.S. versus abroad. For example, foreign economies tend to be less technology-oriented, with an emphasis on sectors like financials, industrials and energy in their stock markets.  Thus, investors have the opportunity to increase exposure to companies in sectors that are not as heavily represented in the U.S. economy. This may provide additional diversification and could support your portfolio if sectors such as information technology, a large part of U.S. equity benchmarks, don’t perform as well.

The fundamentals of international companies appear to us to be moving in the right direction, with the potential for positive earnings growth in Europe and China. This year, we expect strong demand for luxury goods across Asia and Europe as Chinese consumers spend their pent-up savings. Additionally, the warm winter in Europe and a lower likelihood of recession have supported a better-than-expected start to 2023 as more income is spent rather than saved, fueling profits for companies abroad.

Currency

As U.S. investors, we must keep in mind that fluctuations in currency exchange rates between the U.S. and foreign countries may have as big of an impact on our investments as the performance of a particular stock itself. It may benefit an investor to buy stocks in a country whose currency appreciates relative to the dollar. When investing in international stocks, not only are you participating in the earnings of that company, but you also stand to gain (or lose) from the appreciation (or depreciation) of that country’s currency.

The dollar began to weaken toward the end of 2022 as inflation expectations eased, and the market started to expect lower interest rates.  This served as a tailwind (i.e., benefit) to international stocks, and they’ve continued to outperform their U.S. counterparts so far this year. Although it’s notoriously difficult to predict the direction of a currency, it’s hard for us to imagine the dollar strengthening against many currencies amid slowing economic growth, so international stocks may help to offset this risk.

Some people tend to invest only in their own markets (known as “home country bias”) since these securities are familiar to them and may make them feel more comfortable or confident. However, investing internationally can help investors gain exposure to different countries, sectors, companies and currencies. China’s reopening, stronger-than-anticipated economic data from Europe and a weakening dollar have all played a role in the resurgence of international markets. Although investing abroad comes with unique risks, we believe they are generally outweighed by the longer-term benefits. As you consider making an international investment, we think a great place to start is the “3 Cs.” Consult with your advisor to see if international equities may be suitable for your portfolio, given your financial objectives, time horizon and risk tolerance.

¹ International Stock Outerperformance 2022, Bloomberg
² US Outperformance of International Stocks, past decade: S&P 500 vs. MSCI ACWI ex US trailing 10 years, Bloomberg
³ https://www.sifma.org/wp-content/uploads/2023/04/US-Research-Quarterly-Equity-2023-04-27-SIFMA.pdf
⁴ Recession Probability Europe, Bloomberg
⁵ Comparison Global Index vs. S&P 500 Sector Make Up, Bloomberg
⁶ https://fred.stlouisfed.org/series/FEDTARMD

ABOUT THE AUTHOR