Why Own International Stocks?
Doug Walters
International stocks have been a big underperformer this year, but we find inspiration to continue to own them in a surprising place…
Market Review
Contributed by Doug Walters
U.S. stocks were up this week, and over 10% year-to-date. Yet, as we discuss in our Asset Allocation, international stocks have been a significant drag on diversified portfolio performance this year, leading some to ask, “what is the point of diversification?” A recent trip to a ropes course provides a useful analogy.
Retirement – a 10-Foot Wall
This week I participated in some teambuilding exercises with thirty other likeminded individuals who hope to make a positive impact on our community. Our final activity was to get everyone over a sheer 10-foot wall. After the last of us were hauled over the structure it occurred to me that our diverse team had built a well-constructed portfolio which adapted as we got closer to the end of our “retirement.”
So how did we construct our diversified portfolio to stand the test of time?
- Stable Income: Two individuals “sat”, backs to the structure, and with their knees provided a first step towards getting over the wall. This support is like the role of income in a portfolio. Quality dividend-paying stocks and bonds, without much effort, get you predictably part way towards your return goal.
- Growth: Additional participants next provided the lift, similar to the role of stocks. Corporate equities provide the potential for significant growth of the portfolio. This is our most volatile holding with the most potential to take a wrong turn. Without enough growth heft, our wall participant could come crashing back down just like the stock market.
- Protection: The remainder of our group was there to provide support in the event of a crash in the lift. Just like the safe government bonds and cash in a portfolio, this protection was there to provide a safety net, making sure a bad situation is not made worse.
- Diversification: Diversity of thought in our group provided a variety of ideas and solutions throughout the activity, improving our likelihood of long-term success. Whether it is international stocks, gold, or something else, the differences amongst each asset provide an opportunity to improve the long-term risk-adjusted returns of the portfolio.
Just because some of our group flew over that wall with ease (like U.S. equities in recent years), that is no reason to pull away from the well-known long-term benefits of diversification. Would investors have been better off without international stocks this year? Absolutely. But let us not forget that international stocks performed much better than U.S. stocks just last year, and the long-term diversification benefits are well-studied, and we expect will continue to have a positive impact on long-term returns.
Strategy Update
Contributed by Max Berkovich ,
STRATEGIC ASSET ALLOCATION
Straying away from home
U.S. equity markets advanced higher this week and volatility declined to a near six-month low. U.S. bonds stood still, though the 2-year versus 10-year yield spread is hovering near 0.2%. International bonds perked up a bit this week. Slight weakness in the U.S. dollar provided some relief for the Emerging and Developed markets as both finished in the green for the week. Speaking of international markets…
- Investors might find this year that international equities are the biggest drag on their portfolio performance year-to-date. The major contributors to the negative performance of the Emerging and Developed equity markets are a rise in U.S. dollar against international currencies, reduction of global liquidity in the debt markets, and worries that financial trouble in Turkey, Argentina and Brazil may spill over to other countries.
- The reason for international exposure in the portfolio is diversification. Research shows that the addition of international improves long-term risk-adjusted returns and is a vital part of a well-diversified global portfolio. In 2017, international equities outperformed U.S. equities by a wide margin with the S&P 500 up 21.8%, Developed International up 26.6%, and Emerging Markets up an impressive 37.4%.
STRATEGIC GROWTH
Semi-Charmed
The Financial sector managed to pop to the top, beating out Industrials for top dog. The Consumer Discretionary sector was the laggard. In other strategy news…
- NXP Semiconductors NV (NXPI) has had a tough time bouncing back from a deal that never closed. This week the company held an analyst day. During the event, the company announced a $0.25 quarterly dividend and $4 Billion stock buyback, but more importantly, the company reengaged with the investor. NXP outlined its go forward strategy, which includes margin improvement and commitment to returning free cash flow to investors, $9-12 Billion in the next three years. The other side of the merger, Qualcomm Inc. (QCOM), has used the cash it raised for the deal to accelerate its $16 Billion stock buyback.
STRATEGIC EQUITY INCOME
Apples and Honey-Well
Banks had a tough week, but the Financial sector came in second to Consumer Discretionary for the biggest laggard. The Telecom sector was the leader. The sector will disappear next Friday and become part of the new Communications Services sector. In other news…
- Apple Corp. (AAPL) announced at its launch event three new phone models. The iPhone XR, XS, and Max. The XS and Max can be pre-ordered on 9/14, with shipments expected on the 21st. The cheaper XR can be pre-ordered on October 19th.
- Honeywell Int’l. Corp. (HON) released further information on a planned spin-off of its home alarm business. The new company will be called Resideo and trade under the symbol REZI, with its first investor conference scheduled for Oct. 10th.
The Week Ahead
The JOYS of a slow news week means we can talk about quadruple witching
Japan’s Central Bank (BoJ) will announce their decision on interest rates on Wednesday.
- The Street forecasts no change to the interest rate. Some economists opine that U.S. steady rate hikes will force the BoJ to increase their rates to keep up.
Oracle (ORCL) is scheduled to report earnings on Monday after the market close.
- The company is estimated to grow sales by over 2% and grow earnings per share by over 13%.
- Earlier this year, Oracle announced that they are planning to build 12 new data centers, to become more competitive in the cloud space.
Yom Kippur (the Day of Atonement) will begin Tuesday at sunset and will end after the sunset on Wednesday. We extend our wishes for an easy fast to our friends and clients. May you be sealed for a good year In the book of life.
- The Jewish high holy day usually leads to muted trade volumes for the week, but a Quadruple Witching day on Friday may make up for lower volume early in the week.
- Quadruple Witching Friday occurs four times a year when stock index futures, stock index options, individual stock options, and individual stock futures contracts all expire on the same day.
- Witching makes reference to the witching hour because the last hour of the trading day is usually when all of the trading to adjust derivative-linked positions occurs.
Summit of European Union (EU) leaders will gather in Salzburg, Austria to discuss border security and cyberspace. The European Central Bank’s president Mario Draghi will hold a press conference on Wednesday to address the European economy.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 1.2 | 8.7 |
| S&P 400 (Mid Cap) | 1.0 | 7.7 |
| Russell 2000 (Small Cap) | 0.5 | 12.1 |
| MSCI EAFE (Developed International) | 1.3 | -5.9 |
| MSCI Emerging Markets | -0.5 | -12.2 |
| S&P GSCI (Commodities) | 0.7 | 4.9 |
| Gold | -0.2 | -8.6 |
| MSCI U.S. REIT Index | 0.0 | 1.0 |
| Barclays Int Govt Credit | -0.1 | -2.3 |
| Barclays US TIPS | -0.4 | -2.9 |
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