Don’t Let Home Bias Take Away Your Free Lunch
Doug Walters
Home bias may cause you to miss out on the only free lunch in investing. The new year is a good opportunity to become a more worldly investor.
Contributed by Doug Walters , David Lemire , Max Berkovich , Eh Ka Paw
We are all naturally drawn to what is comfortable and familiar. This is known as home bias. Investors are particularly susceptible to this psychological phenomenon, leading to large positions in domestic securities (or even the investor’s own company). Home may feel comfortable, but too much comfort can add unnecessary risk to your portfolio.
US equities represent about 60% of global equities1. Yet depending on the research you read, US investors hold about 80-90% of their equities in US-domiciled securities. This statistic is home bias at work! The problem with home bias is that you miss out on a portion of your free lunch. The one free lunch in investing is the benefit of diversification. Well-diversified portfolios can earn the same return at lower risk. International stocks are a healthy source of diversification to an otherwise domestic portfolio.
Right now, diversification is working. Since the end of Q3 2022, international stocks have meaningfully outperformed. You might feel good that US equities have rallied about 10% since Q3. But developed international is up 20%, and emerging is up roughly 16%. Isn’t Europe struggling under the shadow of the Ukraine war? Isn’t China facing a devastating Covid wave? Yes, and yes, but that news is priced in, and the international pool of equities is very diverse. Japan, Australia, India, and South Korea all face different dynamics and opportunities.
These moves happen fast. Most of that outperformance came in a short span in November. Rather than try to time these swings, we recommend a healthy long-term allocation to international. Most of our strategies have a long-term international target allocation of about 35% of equities. As evidence-based investors, we would never want to miss out on this free lunch. Have a look at your own portfolios. Are you suffering from home bias? Perhaps 2023 is the time to become a more worldly investor!
1. based on the holdings of the MSCI ACWI Index
US equities share of global market cap
Yet US investors typically hold between 80 and 90 percent of the equities in US holdings.
Headline of the Week
Questions of the Week
How high? And then how long? Those questions have dominated market commentary of late and took on even more urgency after the most recent inflation report. CPI, PCE, Core Inflation, and now “Super Core” inflation. There appears to be no shortage of unique interpretations for the direction of inflation and, by extension, Fed interest rate policy and stock and bond market returns. The Fed is believed to be behind the curve once again. At the onset of the inflation surge, the central bank reiterated its belief that all was well and rising prices were “transitory.” Oops – The Fed then tried to play catch up by raising rates, triggering an unpleasant 2022.
The expression “don’t fight the Fed” has been pushed aside as the market seems to be saying to the Fed, “you’ve done enough.” Interest rate increases take a while to impact the real economy, and markets fear the dreaded hard landing. The Fed has taken a firm stance and has pounded the table consistently that the market is underestimating how high the Fed will raise rates as well as how long they will keep rates high. To answer these two questions, something eventually has to give. The next Fed meeting should offer some insights.
The Week Ahead
Another holiday-shortened week will bring earnings, an inflation report, and rate decisions from Asia.
Inflation Station
Tune in to watch yet another inflation report. Next week, the Producer Price Index (PPI) will provide a read on inflation in the manufacturing sector.
- Expectations are for a monthly decline, though a slight one.
- If the estimators are proven right, it will add another tally mark to the “inflation has peaked” camp and, by extension, a less hawkish Federal Reserve.
- Inflation reports abroad will serve the same purpose, with Consumer Price Index in the UK, Japan, and Canada all out next week.
Let it Roll
Earnings Season started on Friday, with some heavyweights reporting next week.
- The big ones include Morgan Stanley (MS) and Goldman Sachs (GS) leading the way on Tuesday.
- Big regional consumer banks PNC Financial (PNC), Truist (TFC), Fifth Third Bancorp (FITB), KeyBank (KEY), and M&T Bank (MTB) report mid-week.
- Procter & Gamble (PG) and Netflix (Netflix) add some consumer insights on Thursday.
Looking East
Japan will have a rate decision, so will China who also reports its Gross Domestic Product (GDP) early in the week.
- Japan surprised everyone last month. Is another surprise in the cards?
- Japan’s yield curve controls are probably more important and will be what investors will be looking for.
- Chinese Gross Domestic Product is expected to have declined from the previous quarter and expended 1.8% from the same quarter last year. Those are unacceptable numbers for the Party Leaders so expect schemes to boost growth to be unveiled.
- Lastly, the Peoples Bank of China is not expected to move rates, but the focus will be on other liquidity boosting mechanisms they may implement to improve growth.
Ski Trip
The World Economic Forum in Davos, Switzerland, kicks off on the 16th and runs through the 20th.
- 2,700 leaders from 130 countries, including 52 heads of state/government, will be represented under the theme of “Cooperation in a Fragmented World.”
- The attendees are expected to grapple with the cost of living, threats of natural disasters and extreme weather, geo-economic confrontations, and failure to mitigate climate change, according to a survey of the World Economic Forum members.
Observance
Martin Luther King Day is on Monday.
- Financial Markets are closed in observance.
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