Market Analysis

Why Foreign Stocks Are Primed For A Comeback

Stay globally diversified, it provides a more stable path.

This story appears in the February, 2015 issue of Forbes.

My 55 2014 stock picks lagged badly. Equal money invested in each, upon publication, less a 1% commission haircut, did four percentage points worse than the same money plunked into the S&P 500 (with no haircut). Why? Mine were only 47% American. So while my picks actually beat the Morgan Stanley World Index (which itself is 58% U.S.) by more than 2%, that’s cold comfort when the S&P fared so much better.

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America has led this whole six-year bull market overall and, with hindsight, for many reasons. Increasingly I hear investors ask if they shouldn’t just junk overseas stocks and stay home.

Unless you’re some kind of supertimer savant (in which case, you’re certainly not reading me), that’s a big mistake. U.S. and foreign have largely traded leadership in fairly long and tricky-to-time rotations. For example, foreign led the last bull market. America led most of the 1990s. And so on. In the very long term the overall difference between both, correctly calculated, is essentially a rounding error. Why?

Counter to intuition, it isn’t about whether the U.S. economy leads or lags. For example, foreign did lead that last bull market–but America did better economically then. Ultimately supply catches up with any demand shifts and often overshoots. Supply shifts control long-term pricing.

If some stock categories get too hot-and-pricey, mass supply is created via stock offerings to tap that cheap money–and when overdone drives it all down. If stocks get too cold, and cheap, supply is eventually destroyed by endless buybacks and cash-based takeovers–capturing those cheap earnings (relative to interest rates). That shoves those stocks skyward, until they rival faster-growing, pricier categories, wherever in the world.

It’s all financial arbitrage, endless, and derived from Stock Market 101. Bank on it. You don’t want to bail on foreign, or be all U.S., just before the cycle swings back overseas–usually when folks are maximally freaked about foreign and see no good foreign future. Maybe now!

Am I confident foreign will lead, here and now? No. Were I, I’d be foreign-only–and a fool. Timing is always tricky. Hence stay globally diversified. It provides a more stable path to get you to that same very long-term equity return.