International Stocks: Why You Shouldn’t Be a Foreigner to Global Diversification

by Alexander Green, Chairman, Investment U
Monday, January 29, 2007: Issue #632

The S&P 500 rose 15.8% in 2006. That’s not bad.

But it’s not particularly good, either. Of the 24 markets in developed countries tracked by Morgan Stanley Capital International, only two, Japan’s and New Zealand’s, did worse last year.

And when you consider emerging markets, the comparison is even starker. India was up 49%. Argentina was up 66.1%. And China was up 78.1%, all in dollar terms.

In short, the best place to invest in 2006 was just about any place but the United States. How about going forward? Are international stocks still the place to be in 2007?

Alex’s 2007 International Stocks Forecast

Absolutely. But not for the reason you might think

International markets have beaten the pants off our domestic market the past couple of years for three primary reasons: stronger economic growth, more reasonable valuations and a shrinking dollar. (A declining greenback increases the foreign currency-denominated returns for Americans.)

On the basis of assets and earnings, foreign stocks are still cheaper than their American counterparts. But not nearly as much as they were three years ago.

Economic growth is also stronger overseas – particularly in Europe and in developing markets like China and India – but, as we all know, growth can be a fickle thing. The year can start with a bang and end with a whimper. (Anyone remember 1990, the year Saddam rolled into Kuwait?)

And, yes, the dollar has been a one-way currency lately. But with trillions of dollars changing hands in the currency markets every day, no one can promise that the dollar will finish the year in the paper shredder again.

In short, right now the trend is your friend in international markets. But it may not be a loyal friend.

For that reason, the potential for higher returns isn’t the only reason you should invest in international markets. Perhaps it shouldn’t even be your primary one

International Stocks Lower Your Portfolio’s Volatility

The world’s most sophisticated investors – institutions and high net-worth individuals – know that global diversification not only increases returns, it also reduces the volatility of your portfolio. That’s because foreign markets don’t all march in the same direction at the same time.

Less volatility generally means you’ll stick with your stocks longer. And I need hardly remind you what happens when you do. No asset class has outperformed common stocks over the long haul. (Not bonds, not real estate, and certainly not gold, the perennial standby of bearish commentators everywhere.)

But do you really need your stock portfolio to be less volatile? In my experience, yes.

Investors often claim during periods of rising stock prices and low volatility that they’ll stick to their guns no matter what the market throws at them. But, as a former money manager, I can tell you that promise goes out the window whenever the market starts coming apart at the seams, which it tends to do every few years.

“I know I said I’d stick with stocks for the long haul,” a client would typically say. “I know I said I’d even buy more in a downturn but, heck, I never expected this to happen.”

“This,” of course, is something different each time, something totally unexpected. It could be an economic downturn, a currency crash, a political crisis, a hedge fund collapse or a major terrorist attack. These things have all caused the market to keel over in the past. And there’s no reason to believe that any of these – or something new and unexpected – won’t cause it to happen again.

So anything that reduces your portfolio’s volatility, giving you a better chance of executing your financial plan – and sleeping at night – is always a plus.

If you’re looking for a quick way to diversify your stock portfolio internationally, consider iShares MSCI EAFE Index (AMEX: EFA) for developed markets or iShares MSCI Emerging Markets Index (AMEX: EEM) for emerging markets.

Good Investing,

Alex

Today’s Investment U Crib Sheet

• Portfolio diversification is the first of what we call our Four Pillars of Wealth. There is a free report that outlines the “four pillars,” and introduces our asset allocation model, which is based on the investment formula that won Dr. Harold Markowitz the Nobel Prize in finance.It can boost the returns and lower the volatility of your portfolio.
• How low is the volatility in U.S. stocks right now? Reading the CBOE Volatility Index (^VIX) is one way to find out. The VIX tracks projected market volatility in the options of the S&P 500. It’s often referred to as Wall Street’s “fear gauge.” And it generally moves in the opposite direction of the S&P. Last week, for example, as stocks remained close to multi-year highs, the VIX checked in at multi-year lows, around 9.9. In 2000, the VIX climbed as high as 30.

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