Resources/Weekly Insights

Volume 13, Edition 24 | September 21 - September 27, 2024

A Good Time for a Worldly Portfolio

Doug Walters, CFA

With international stocks showing glimmers of strength, now is a good time to check your portfolio for signs of home bias.

Contributed by Doug Walters, David Lemire, Max Berkovich

Investors often gravitate towards what they know best—their home country’s markets. This tendency, known as “home bias,” can limit potential returns and expose investors to unnecessary risks. Strength this quarter in international markets provides an excellent opportunity for investors to ensure they are properly diversified.

Avoiding the Trap of Home Bias

Home bias is real and commonplace. Behavioral psychologists have shown that investors are biased towards domestic markets in their portfolios, which is not based on science. Home bias can increase portfolio risk by overly concentrating your portfolio in one economic environment. Lately, with the S&P 500 so strong, it may feel like there is no use investing outside of our home US market. But we are not immune to downturns, and diversifying internationally can spread exposure across different economies, industries, and currencies.

As a result, when US stocks are underperforming, international stocks may provide a buffer, helping to stabilize your overall portfolio. Those, like us, who practice opportunistic rebalancing can systematically sell high and buy low across these markets as they wax and wane, capitalizing on the advantages of diversification.

Compelling Current Trends

A few recent developments make international markets particularly interesting today. The first is one of valuation. The strength of the US market has pushed valuation well above the long-term average. That doesn’t mean the US market has overshot and is set for a pullback, but historically, points of high valuation have been marked by below-average returns going forward. International markets, by contrast, are not dogged by this headwind. Valuations look comparable to the long-term average.

Another consideration is the Fed’s rate cuts. Last week, they began what is expected to be a fairly significant cutting cycle. All else equal, when US rates fall, so does the demand for, and strength of, the US dollar. Pricing of international stocks (again – all else equal) will go up in dollar terms. In the real economy, “all else” is never equal, but it is a reasonable assumption that the value of your international investments will rise as the dollar falls.

Preparing for the Unknown

It would be easy to look at returns of the last five years and wonder why you’d ever want to include international exposure in your portfolio. Those with US home bias are likely feeling quite smug. But the diversification and risk-reduction benefits are real, and at some point, US returns will lag. Over the past quarter, in fact, international developed and emerging stocks have outperformed the US, and that trend has accelerated in the past week. Is this the beginning of an extended period of international dominance? We don’t predict; we prepare. And proper preparation includes a well-diversified portfolio, absent of home bias.

6%

Emerging Markets performance was strong this week

Our core Emerging Markets fund (EMGF) was up over 6% this week as China began actively defending its economy.

Headline of the Week

Bazooka 2.0

During the Great Financial Crisis of 2008, China fired a monetary and fiscal bazooka that helped fuel global growth while cementing China’s role as the world’s factory floor. Fast forward to today, and they are trying to re-load their weapon. However, this time, it may not pack the same punch.

The US has emerged from the pandemic strongly thanks to innovation (AI) and healthy consumer balance sheets, but China has not. A prolonged property slump has decimated consumer confidence and sapped their willingness and ability to spend. Increased factory production does not seem capable of breaking the malaise. Economists agree that more needs to be done to boost consumption rather than more industrial production. But that opinion runs into policy choices that are unpalatable to China’s leadership.

This week saw China try to boost the firepower of its latest stimulus, but it did not lay out a clear path to address the current issues. Markets have reacted favorably to the moves, but the staying power of those moves is still an open question.

The Week Ahead

The jobs report on Friday, the Institute of Supply Management’s (ISM) Purchasing Managers Index (PMI), and the Bank of England’s (BoE) rate decision are slated to be the key market drivers next week.

Can I Buy an “I” Please?

As mentioned last week, as the inflation battle nears victory all eyes turn to the performance of the economy, and the PMIs are frequent gauges of that.

ISM’s PMI measure comes in two forms: manufacturing and service.
Manufacturing is expected to come in weak at 47.7. A measure below 50 indicates contraction. However, it is supposed to improve from the August report.
The service’s flavor is expected to continue to chug along above the 50 level.

Back of the Pack

The Bank of England has been a laggard when it comes to rate cuts, but traders now believe they will join the party this week.

U.K. will also report a final revision of its Gross Domestic Product (GDP) for the 2nd quarter, but it is unlikely it would sway the central bank.
The economy expanded fractionally, 0.7% in the first quarter and 0.6% in the second quarter, according to the previous reading of the second quarter numbers.
According to a Reuters article, besides the pockets of persistent inflation, Britain’s finances are in a dire state, and consumers are at their most miserable for six months.”
A rate cut may help the consumer, but the government also needs to figure out some way to ease the pain when it unveils the October budget.

Workload

The First Friday of the new month brings the non-farm payroll report, and there are further jobs-related reports like Challenger Gray and the ADP reports during the week.

Current estimates have the U.S. economy producing 145,000 jobs in September, which would be slightly more than in August.
The other things to watch are the unemployment rate and the hourly earnings numbers.
Unemployment is slated to remain steady at 4.2%, and hourly earnings are expected to slow slightly, from 0.4% to 0.3% on a month-over-month basis.
A hot jobs report may help ease concerns of a slowing economy but could also dampen hopes for another jumbo cut from the Federal Reserve.

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