The start of the year was disappointing for the U.S. market with the broad based S&P 500 down 3 percent for the month of January. During this same period international markets were generally positive in their local currencies, and even garnered small gains in U.S. dollar terms.
European stocks tended to be the strongest performers, though emerging markets were also slightly positive for the month. This was a significant turnaround from the past two years, where international markets significantly underperformed the U.S. market.
There are several reason to account for this better relative performance for foreign markets. The most obvious is that foreign markets are considerably less expensive than the U.S. market. This is largely due to the strong relative outperformance of the American market over the past several years.
Another factor helping foreign markets is that their monetary authorities are taking stimulative actions. This is the case both in Japan and countries in the Euro block. These are actions the U.S. instituted several years ago, but are now ending, as our economy is recovering.
Finally the weaker currencies in Europe and Japan tend to be a positive for their multinational companies, making their goods more competitive versus U.S. producers. While U.S. manufacturing is still expanding, a report that came out for the month of January shows the pace of growth is slowing.
For the most part a strong U.S. dollar is a positive. That is because consumers benefit with lower prices, with the most obvious being the price of gasoline. However, for U.S. companies the effect of a stronger dollar is more mixed. Those that sell primarily in this country benefit because the American consumer has more spending power; however, those that sell overseas are hurt because U.S. goods have become more expensive.
With the U.S. stock market off to a rough start in the month of January some might think this will be a bad year for our stock market. However, last year the stock market did poorly in January, and still wound up having a decent year. Therefore, individuals should not place too much weight on one month’s performance.
Given that foreign operations constitute a significant portion of sales for many U.S. companies the strong U.S. dollar will have an impact. We are seeing that effect for many companies with their just released earnings reports for the last quarter. This implies that earnings growth for many U.S. companies will be rather lackluster this year.
Relatively weak earnings growth with a stock market that already is somewhat expensive might give investors caution. However, with interest rates at exceedingly low levels stocks still look relatively more attractive versus bonds.
With respect to foreign stocks their likelihood of doing better versus the U.S. is certainly greater now given their relative discount in price. This discount in price is due to the greater uncertainty involving their respective economies versus the U.S.
There are some who feel that because U.S. companies garner a significant share of earnings overseas that they already have international diversification investing with American corporations. While that is true to some extent, investing in foreign markets add an additional element of diversification.
Even with international markets looking relatively more attractive currently, I would not recommend that someone place a majority of their stock market money overseas. Allocating 20 to 25 percent would be reasonable, though some with higher risk tolerances could have a greater percentage.
Each year there will be some markets that perform better relative to others. Unfortunately, no one is smart enough to say, which respective market will do the best. That is why we diversify, though the long period of the U.S. market performing better than foreign ones might be coming to an end.
