How many things can you buy today for the same price you could have eight years ago? If I told you stocks were on that list, you might wonder on what planet. If you’ve been following the US stock market, you could cite the Dow Jones Industrials, the NASDAQ, the S&P 500, and any number of other indexes to prove me wrong. But despite their dominance of US financial media coverage, they omit most of the world’s stocks.
We’ve talked before in these pages about the risk of buying US stocks at these elevated levels. The US stock market is in a bubble, trading at valuations comparable to the top in 1929. Only in the dotcom mania circa 2000 has the US market been more overvalued. And since valuation is the single best indicator of long term prospective returns, the outlook for returns over the next ten years is far below historical averages.
Not all stock markets are in a bubble however. Most of the rest of the world is not. Credit where credit is due … this is by no means my own analysis. We have experts that have already studied the matter deeply and any effort of mine to reinvent the wheel would be a waste of time. Two of the most respected of these authorities in long term return forecasting include Research Affiliates and Grantham, Mayo, Van Otterloo. (GMO Quarterly Letter) Both rank the long term outlook for non-US stocks well ahead of that of US stocks using sophisticated methods that take into account valuation. Note that they separately rank the so-called foreign developed markets and emerging markets. The division between what is “developed” and “emerging” however is a judgment call and subject to change; and since both rank higher than the US market for our purposes we’ll consider them together as a single asset class.
There’s more than one good reason to diversify globally though. Even if the relative merits of non-US stocks weren’t compelling on their own, it’s a good idea anyway, as this article on HumbleDollar explains. It just happens that the valuation case makes it especially attractive. A current yield of around 3% makes it reasonable for income investors to own without counting on selling at higher prices in order to earn a return.
There are convenient ways to invest in the non-US world stock market. Let’s highlight one here that I consider the best for US investors.
Today is the eighth birthday of Vanguard’s Total International Stock ETF, which goes by the ticker VXUS. Vanguard launched the fund on January 26, 2011, at a price of $50 a share, and it traded in the upper forties and lower fifties for several months thereafter. The past several months it’s been trading in the same range, closing the week at $50.30. While the US stock market has roughly doubled in those eight years, the rest of the world’s has not. With this fund you can literally buy 2019 stocks at 2011 prices.
So if the outlook for foreign stocks is better than for US stocks, how come market efficiency hasn’t bid them back to parity? Time frame. We’re talking about a time frame in the neighborhood of a decade. Many investors and traders are positioning for the next quarter, week, day … some even for much less. If you’re not one of them, this is a positive, not a negative for you. There are reasons for international stocks to be cheaper at the moment; European problems such as Brexit, Italy, and an insane central bank, China’s slowing and debt-ridden economy, etcetera. On the other hand US stocks are overpriced not because the near term outlook is so great but because corporations have been buying huge amounts of their own stock, often borrowing in order to do it, in many cases mostly for the benefit of insiders whose compensation is heavily dependent on stock options. If you’re not one of them, this is a negative, not a positive, for you.
VXUS is no mere specialty fund covering a small slice of the world’s stock market. It’s not a deep value fund or focused on any one industry. It covers virtually the entire world stock market except the US, hence the ticker. Vanguard’s US counterpart, VTI, covers basically the entire US market and includes about 3,508 stocks. VXUS includes about 6,374, and represents nearly 95% of the world’s land mass, about 95% of its population, and 75% of its GDP. The US, at about one quarter of the world’s economy, has about half its stock market capitalization, a reflection of the overvaluation cited above. If you own only US stocks, you are in effect selecting just one slice of the market, and here in 2019 a very richly valued slice at that.
I use this fund myself to balance and diversify my stock allocation. If you consider doing so, please familiarize yourself with it by consulting the information available at Vanguard VXUS.
This is not to suggest investors should completely avoid the US stock market or dump everything into foreign stocks. Nor is this a timing suggestion or a prediction that foreign stocks will go up over the next week or even the next year or two. In fact we’ve written extensively that stock prices as a whole look especially vulnerable to decline over the next year or so. But if you look at your portfolio and find that most or all of your stock exposure is concentrated in the US, a fund like VXUS can make it easy to globally diversify. And this is not to say that that non-US stocks won’t decline in price if US stocks do … historically it’s likely they will … but at least the risk comes with compensating prospects for long term returns. Investing always comes with risk; the problem is making sure the chance for decent returns goes with it.