STA Weekly Report – Why Global Diversification is Increasingly Important
Written by Luke Patterson | Thursday, February 21st, 2019
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.
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
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
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.
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.
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.
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.
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
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
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
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.
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