In today’s post, we’ll explore:
- The recent performance of US market compared to other regions
- How many other markets globally may present favorable opportunities for investors
- The cognitive bias preventing many from capitalizing on these opportunities
US Equity Valuations
As illustrated by the chart below, US markets have had quite a run over the last five years. US markets saw total five-year returns of 199% – outperforming MSCI All-Country Index (by 2.7% annually), Europe (by 4.3%), the Emerging Markets (by 4.6%), and Japan (by a whopping 11.2%).Source: MSCI data via mpi Stylus.
Subsequently, US equity valuations are now higher than many of their international counterparts — the outperformance has created a gap between US market valuations and most other regions and countries. After the 2008 financial crisis, US equity valuations rose steadily, while valuations in other markets (particularly those of Europe and the Emerging Markets) did not.Source: MSCI data. Author’s calculations. PE Ratio is 10-year average earning divided by current price.
Because of this valuation gap, it should be clear that proper international diversification is as important now as it ever has been. So why are more investors not taking advantage of this opportunity?
Home Country Bias
The above data notwithstanding – there is also an interesting cognitive bias at play here, which causes US residents to tend toward focus on domestic equity markets. This bias is known as the “home country” bias – a well-known, extensively documented behavior that causes investors to prefer owning the securities of their home country. Because of this bias, investors consistently over-own investments in their own country, and fail to adequately diversify internationally.
And it isn’t an isolated incident – “home country” bias is prevalent across countries and time periods. The chart below depicts just how wide spread and persistent it is.Source: Goldman Sachs Global Economic Weekly. April 2014.
Home bias is measured by how heavily residents over-weight their home country – with a zero home bias meaning that securities are held in perfect proportion to their share of global market capitalization.
Notice that most countries have a home bias around .80, meaning they over-weight their home country by 80%. This bias has not meaningfully changed over the past decade.
What This Means for Investors
Let’s face it, limiting your portfolio to depend solely on the prospects of your home country (thus nullifying the benefits of a global diversified portfolio) is not a sound long-term strategy regardless of market conditions. However, given the recent strong performance of US equities, this bias could be particularly harmful right now.
The US is not the only market in which to obtain equity exposure; and in fact many other markets globally may present favorable opportunities for investors.
Consider the map below. When viewed at a country level, it should now come as no surprise that the United States and the rest of North America stand out as valued on the high end (shaded red). On the other hand, many of the countries in Europe and those comprising the Emerging Market index are at much more attractive valuation levels (shaded green).Source: MSCI Data. Author’s Calculation. Valuation rank based on average of PE Ratio, Price to Book Ratio and Dividend Yield.
As you can see, there are areas of opportunity to expand your search outside of the US and go globetrotting with your portfolio—both in terms of diversification benefits, as well as more attractive values.
It may be difficult emotionally to diversify away from the US market. However, overcoming these emotional biases is a necessary step toward staying disciplined. And with an intentional asset allocation and a predetermined risk tolerance, you will be much better situated for investment success.
Interested in learning more about how Cordant can help you optimize your investment portfolio? give us a call at 503.621.9207.
Click here for disclosures regarding information contained in blog postings.
We are sorry that this post was not useful for you!
Help us improve it.
How we can we make this post more useful?