Managing Investment Risk
Updated: Sep 14
“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” —John Templeton
In our conversations with clients recently, we consistently discuss helping them stick to long-term financial goals despite the staggering market heights and constant barrage of negative news. There is a memorable scene in “Alice in Wonderland” that sums up this conundrum nicely. Alice asks the Cheshire Cat, “Would you tell me, please, which way I ought to go from here?” The cat replies, “That depends a good deal on where you want to get to.”
It seems most investors acknowledge that consistently trying to time the market is a fool’s errand. For us, this is a primary reason why we're data centric and market agnostic. Emotions can tear a hole in the most solid of plans. So, for us, there’s no need to question, "Where are we going?" especially within the confines of a goals-based process. Owing to the Templeton quote above, couldn’t you make the case that equity markets fall in all four camps — pessimism, skepticism, optimism, and euphoria — simultaneously?
In this blog, we look at U.S. stocks in comparison to their international counterparts. The last decade has not been kind to international stocks on a relative basis. Is this an area of concern for investors going forward? We review the data and help shed light on that question.
“The first rule of fishing is fish where the fish are.” —Charlie Munger
The performance divergence between U.S. stocks and the rest of the world is staggering in its longevity and consistency. Take almost any rolling time period over the past 10 years and you will find that U.S. equities, on the whole, outperform international equities. While the historical correlation between these asset classes is high, the daily accumulation of small differences in performance leads to a large divergence when measured over a meaningful amount of time.
There are many examples from recent history, but August provides yet another compelling example of the difference (as of August 30):
U.S. stocks: near 3% for the month
foreign developed equities: up approximately 1%
Taking a step back from one month to a larger sample of 10 years, the magnitude becomes clear:
U.S. stocks: almost 360%
foreign developed equities: returned a little under 90%
emerging markets: just over 50%
These differences feel almost like different classes of assets altogether.
Does this mean diversification should be cast aside? Not quite. Most professionals agree diversification is a good thing, but that doesn’t mean it comes with no cost. As with most things in life, there is an optimal balance to be achieved. If diversification is good, then precise diversification is better.
In our view, this highlights once again the importance of being adaptive by using an objective, systematic process. While startling, these vast performance differences represent a tremendous opportunity to outperform the competition and provide superior returns.
For us, applying Munger’s principle means first having a process for monitoring and using many asset classes, including international equities, but secondly having rules that govern how much exposure is actually budgeted. Like now, there have been other significant stretches over the last decade when our equity exposure was more concentrated toward the U.S. Static portfolios containing meaningful allocations to foreign and emerging indices would not have fared nearly as well.
Like all trends, the outperformance of U.S. versus international is unpredictable and can persist for a long time, creating an edge for us to exploit. Our trend following processes give us an objective lens by which to view the world and take advantage of these opportunities when they arise. When you want sound, measured investment advice and expert insights into your asset allocation, contact Solas Wealth.