Both EAFA and Emerging Market indexes are higher than the S&P 500 in 2018, and that has many portfolio managers looking to diversify through overseas stocks and bonds.
Both are stock indices created by Morgan Stanley to measure market performance of international stocks and equity markets.
“Diversification of return streams is one of the best reasons to consider investing in foreign stocks,” said Cara Esser, a senior investment research analyst and investment committee member at Mesirow Retirement’s Retirement Planning and Advisory group.
“A case can be made that now is a good time to increase exposure to non-U.S. stocks,” Esser said.
While U.S. gross domestic product hasn't grown in any spectacular fashion since the 2007-08 global financial crisis, she noted, its growth has been stronger than most other developed countries and has been fairly consistent.
“But that may be changing,” Esser added.
Other Wall Street money managers agree, noting that the stage is shifting towards better portfolio results in foreign bourses.
“I’ve always been a big advocate of allocating a portion of the portfolio into both foreign equities and bonds,” said Clifford Caplan, a wealth manager at Neponset Valley Financial Partners in Norwood, Mass.
From 2008 through 2016, returns on both foreign equities and bonds significantly lagged their U.S. counterparts, he said.
“However, last year was a different story and so far this year, foreign equities continue to outperform U.S. equities,” Caplan said.
Two Big Reasons
There are two compelling reasons, Caplan said, why foreign stocks and bonds will continue to produce better:
A rebound in major nations. “The developed countries such as Euroland and Japan have resolved many of the headwinds that caused the under-performance to begin with,” he said.
In Japan, the stimulus of the government investing in the stock market and correcting much of the corporate governance issues that plagued Japanese corporations have resulted in strong gains, Caplan noted.
In Europe, a stable investment environment coincided with some fiscal stability in Greece, among other factors.
Emerging markets bubbling to the top. Emerging markets, despite some recent softness, will be “a big growth play,” Caplan said.
“In many emerging markets, the middle class is expanding, led by China and, more recently, India,” he said. “The past headwind of being dependent on exporting to the U.S. has been reduced as roughly 40 percent of trade in the emerging markets is between each other.”
Many of the largest emerging markets were commodities-based economies. But new technology and health care companies have appeared on the scene, making emerging markets less susceptible to swings in the global economy, Caplan explained.
While Caplan isn’t abandoning U.S. equities, he is increasing allocations to foreign equities from 20 percent to 30 percent, and beefing up foreign bond allocations by 5 percent.
“With the exception of financials, health care and small-cap stocks, much of the U.S. stock market is over-valued and allocations should be reduced accordingly,” he said.
'An Enormous Profit'
Some international landing spots deserve more focus at the midpoint of 2018.
“The best play international opportunity right now is China,” said Alexander Lowry, professor of finance at Gordon College in Wenham, Mass. “China is on the verge of massive technological changes and U.S. investors who focus the best companies will make an enormous profit.”
One China company Lowry recommends is Tencent Holdings.
“If there's a single winner in technology revolution going on in China right now, that company is Tencent,” he said. “The key to succeeding in the New China economy is owning the screen time of millions of Chinese. Screen time in China equals a smart phone. And no one owns more screen time than Tencent.”
A good way to leverage Chinese stocks is through the KraneShares CSI China Internet Fund, Lowry said.
“Great Chinese stocks like Tencent, Alibaba, and Baidu make up nearly 30 percent of this fund,” he said. “The top eight holdings make up more than 50 percent of KWEB.”
Some money managers point to exchange-traded funds as an easy and effective way to ease clients into overseas stocks and bonds.
“Rather than own a few individual stocks, ETFs make it easy to own large baskets of stocks from individual asset classes, countries, or regions,” said Gabriel Pincus, president of GA Pincus Funds in Chicago.
All of Pincus’ portfolios contain, at minimum, five ETFs covering a blend of U.S. and foreign market segments (US Small Cap, US Midcap, US Large Cap, International ex-US, and Emerging Markets).
“Doing so gives us the diversification needed to lower portfolio volatility and low volatility of returns,” he said. “That should be the desire of most financial advisors.”
Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected].