As the graphic from the Wall Street Journal below shows, the US stock market has been a star the past five years compared to the rest of the world.
Not surprisingly, many investors are now overweight US stocks. This is a mistake on a couple levels. First, as I’ve discussed before, the US stock market is currently expensive based on valuation metrics such as Market Cap to GDP or the Shiller P/E ratio. Not only is the US market expensive relative to its own history, but it’s very expensive compared to the rest of the world. The US economy makes up nearly 20% of global GDP, yet the US stock market makes up nearly half of global stock market capitalization. The table below, produced by Mebane Faber, ranks global equity markets based on an average of 4 cyclically adjusted valuation metrics (price/earnings, price/book value, price/dividends, and price/free cash flow). As you can see, the US ranks near the bottom of the table as one of the most expensive markets globally.
Studies have shown that diversifying into international equities can improve risk adjusted returns. Additionally, diversifying internationally can help investors avoid disaster that occasionally strikes an individual country’s stock market. If you’re currently heavily weighted towards the US in your portfolio, now might be a good time to look at getting more exposure to cheaper international markets.
For further info on avoiding the home-country bias in your portfolio, check out Patrick O’Shaughnessy’s piece here or search for some of Mebane Faber’s books and posts which also do an excellent job.