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STA Weekly Report – Why Global Diversification is Increasingly Important

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INSIDE THIS EDITION:
Major Stock Index Test Overhead Resistance
Financial and Materials Sectors Test 200-Day Line
401k Plan Manager*Updated on 12/31/2018

Since the financial crisis domestic stocks have outperformed stocks from abroad. Despite periods where international stocks have outperformed domestic stocks during this period, many investors have begun to question whether having diversified global exposure to stocks still makes sense.

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Source: STA Wealth Management

This is unsurprising, considering international and emerging market equities’ relative underperformance relative to domestic stocks and their higher volatility profile. Also, headlines about BREXIT fallout, prospects of a global slowdown, and continuing trade uncertainty have further added to investor trepidation about putting money to work outside of the United States.

However, we believe this approach is a big mistake that could hurt investor risk adjusted returns going forward for several reasons. To start, the U.S. makes up approximately 25% of world GDP.

By excluding international investments from a portfolio’s allocation, investors are potentially turning a blind eye to three quarters of the world’s economic output. However, that isn’t the only reason investors should keep international exposure in their portfolios.

A Larger Opportunity Set

By considering international equities, investors naturally open themselves up to more investment opportunities. To illustrate, all we must do is look at the number of US stocks compared to the number of non-US stocks represented in the MSCI All Country World All Cap Index.  Currently, this index is comprised of more than 14,000 companies but only approximately 3,500 are from the US. To put it another way, if investors only invest in domestic stocks, they don’t have access to 75% of the investable universe and can miss the opportunity to invest in stocks as broadly known as BMW and Sony, which are traded internationally.

Better Diversification

As a direct result of selecting investments from a broader investment universe, it is possible to build an investment allocation that can improve the overall diversification in a portfolio. While the diversification benefit of holding non-US equities between 1970 and 1996 was significantly larger than it has been since 1997, there is still some benefit realized when holding more geographically diversified equity exposure.

Lower Volatility

The most important reason to include non-US stocks in an overall allocation is that doing so can reduce overall portfolio volatility. The reason is largely due to the shifts in equity performance that naturally occur during a market cycle. In other words, there are times when domestic stocks outperform non-domestic stocks and vice versa.

Source: Fidelity

As the chart below shows, however, there is a sweet spot, typically between 20% and 40% in non-U.S. stocks, that leads to a more optimal volatility profile. As investors determine their overall asset allocation and geographic mix, they should thus consider an allocation to non-US stocks.

Major Stock Index Test Overhead Resistance

All three major U.S stock indices are testing overhead resistance barriers. Chart 1 shows the Dow Industrials right up against its early December peak at 26,000. That’s the Dow’s first test of a previous peak formed during the fourth quarter selloff.

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In addition, its 14-day RSI line (upper box) has reached overbought territory at 70 for the first time since early October. That combination suggests that this might be a logical spot for the Dow to encounter some short-term profit-taking, or consolidate some of its recent gains. If it does pull back, it could retest support at its 200-day average.

Chart 2 shows the S&P 500 nearing its December intra-day peak at 2800. It, too, is overextended. The upper box shows its more sensitive 9-day RSI line forming a second peak above its 70 line. That suggests that the SPX may also be vulnerable to some profit-taking.

Chart 3 shows the Nasdaq Composite Index struggling with its 200-day average (red line) and potential resistance at its December high. Its 14-day Rate of Change (ROC) line (top box) shows some weakening in short-term momentum.

Financial and Materials Sectors Test 200-Day Line

Financials have had a good week. Chart 4, however, shows the Financial Sector SPDR (XLF) in the process of testing its 200-day average. Materials stocks have also picked up this week. Chart 5, however, shows the Materials SPDR (XLB) also encountering some selling at its 200-day line. This week’s buying in materials came mainly from gold and copper stocks. Both commodities are having a strong week. Yesterday’s chart showed the price of gold rising to the highest level in ten months. Chart 6 shows copper climbing yesterday to the highest level since July.  Crude oil also hit a three-month high yesterday, which suggests that investors are taking a second look at commodity assets.

Weekly Global Asset Class Performance

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer

Mike Smith, President

Andrei Costas, Senior Investment Analyst (Equity Strategies)

Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Maximizing Opportunities in Today’s Trade Market

Event Date:  February 26, 2019

To attend, click link to Register Now

If you are a business owner or executive that is looking to learn how to maximize import/export trade in today’s global markets, this event is for you.  STA is proud to co-sponsor this event and breakfast discussion where a panel of trade experts will further explore the current trends and opportunities happening globally and ideas to optimize your global trade business activity.

Important Disclosure:
Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice.  A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.

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