Why Your Portfolio Needs International Stocks

Key Takeaways

• The U.S. share of the global stock market value has climbed to nearly 60%, which is really out of proportion to its 25% share of the global economy.
• The U.S. equity market looks high-priced, top-heavy, and low-yielding compared with global counterparts.
• No matter what currency you look at, the United States has massively outperformed equities outside of the U.S.
• We assume that stocks and bonds are negatively correlated, but last year we saw both of them plunge in tandem. Whether it’s stocks in the U.S. and outside of the U.S., there are shares of businesses that are often responding to the same sort of stimuli, whether it is macroeconomic or at the sector level or capital flows.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Do you really need to own international stocks in your investment portfolio? Joining me today to discuss why there are both tactical and strategic reasons investors should broaden their opportunity set is Dan Lefkovitz. Dan is a strategist with Morningstar’s Indexes team.

Dan, good to see you today.

Dan Lefkovitz: Great to be with you, Susan.

U.S. Stocks Continue to Climb

Dziubinski: In your research, you report that the U.S. share of the global stock market value has climbed to nearly 60%, which, when you think about it, is really out of proportion to its 25% share of the global economy. So, why such a big difference?

Lefkovitz: If we take our time machine, Susan, back to 2008, 15 years ago, it’s hard to believe, U.S. equities represented less than 40% of the Morningstar Global Markets Index, which is our broadest gauge of stocks across developed and emerging markets. Of course, that was the global financial crisis, a crisis that originated in the U.S. And the notion that U.S. equities would dominate so thoroughly in the years to follow that crisis would have really been hard to fathom at that point. But an investment in the broad U.S. equity market would have quadrupled over the past 15 years, whereas an investment in the global ex-U.S. index would have just gone up 1.7 times in U.S. dollar terms. So, it’s a huge discrepancy. And I think it’s a story of both U.S. strength and weakness outside of the U.S.

You’ve talked about the trillion-dollar club, the cohort of U.S. mega-caps like Apple and Microsoft, now Nvidia, that have been so profitable and have grown so much. We’ve even seen companies like Tesla and Meta that only came to market after the financial crisis, and now they are some of the largest in the world. We just haven’t seen anywhere near that kind of dynamism outside of the U.S. In Europe, those markets are still dominated by old economy sectors like industrials, financial services, consumer staples. In the U.K., of course, there was Brexit, which was a setback. Japan sort of muddled along for years. In China, we did see the rise of the internet giants, but they got kneecapped by the government a few years back. So, now, if we look at the top 20 constituents of the Morningstar Global Markets Index, 18 of the top 20 are U.S. companies. It’s really astounding.

Don’t Neglect Investments Outside the U.S.

Dziubinski: Wow, wow. You recently wrote a new research paper, which we’re going to provide the link to for those who are interested, and you say, and I’m quoting you, so I’m going to make sure I get it right, “The U.S. equity market looks high-priced, top-heavy, and low-yielding compared with global counterparts.” So, let’s unpack that statement one by one. First, let’s talk about U.S. stock market valuations relative to those of non-U.S. markets today.

Lefkovitz: Our Morningstar US Market Index trades at about a 60% premium to our global ex-U.S. index. Now, there has long been a premium, and it’s justifiable to some extent, given the growth orientation of the U.S. market and the profitability of some of the top companies in the U.S. But the valuation gap has really widened dramatically in recent years. So, if you go back 15 years, the valuation gap was more like 15%. So, a lot of the performance differential that we’ve seen between U.S. equities and non-U.S. equities is down to that valuation gap widening, what they call multiple expansion.

Dziubinski: Got it. So, now, you also say that the U.S. stock market looks top-heavy. So, first, explain that and talk about the concentration that we have here in the U.S. stock market compared to the concentration or perhaps lack thereof in other international markets.

Lefkovitz: Yeah. Again, this has long been the case, and it’s justifiable. The U.S., of course, is a single market. Our U.S. market index has about 1,500 stocks, whereas global ex-U.S., over 6,000 across 47 markets. But again, the trajectory, the magnitude of the differential is really dramatic. So, the top 10 companies in the U.S. market are 27% of the overall market value. That’s risen from 16% in 2008. And outside of the U.S., it’s been much steadier. So, this has been covered in Morningstar.com and elsewhere. U.S. investors who hold a market portfolio really have outsize exposure to a small number of stocks. There’s a lot of stock-specific risk in U.S. equities right now.

Dziubinski: Interesting. And then, lastly, you say that U.S. stocks are lower-yielding in general than their international counterparts. Talk a little bit about that for us.

Lefkovitz: Yeah. So, the dividend yield on the U.S. market index is 1.6%. Dividend yield on global ex-U.S. is 3.2%. So, it’s exactly double. It’s partly down to sector. So, the kinds of sectors, the value sectors like financials and industrials that are more heavily represented outside of the U.S. tend to be more dividend-rich. A lot of the tech-oriented names in the U.S. market don’t even pay dividends. But it’s also connected to valuation. Because when price goes up, yield goes down. And it’s a problem for both income investors and total return investors. A big chunk of the long-term returns that we get from equity markets is reinvested dividends.

How Has the Strong Dollar Played a Role in U.S. Stock Performance?

Dziubinski: You mentioned a little bit earlier the U.S. dollar. What role has, in general, a strong U.S. dollar played in that outperformance of U.S. stocks?

Lefkovitz: Yeah, it’s part of the story for sure. It’s not the whole story. No matter what currency you look at, the U.S. has massively outperformed equities outside of the U.S. But “King Dollar,” as they call it, has really been on a long run of dominance. In 2022, the euro fell below dollar parity for the first time in 20 years. The yen hit an all-time low against the dollar. But currency leadership, like market leadership, is cyclical. It’s changeable. So, we shouldn’t just assume that dollar strength will persist.

Dziubinski: Right. So, now, let’s talk a little bit about the strategic case for international stocks. And Vanguard founder, who we talk about very often at Morningstar, Jack Bogle, very famously argued that international stocks don’t really merit inclusion in a portfolio because if you own U.S. companies, specifically the big U.S. companies, they’re getting so much of their revenue from international markets that you don’t really need international stock exposure. What say you?

Lefkovitz: Yeah. Well, far be it from me to disagree with St. Bogle. But yeah, I mean, we all have our home-country bias. It is true that when we look at the geographic sources of revenue for the U.S. market index, about 40% of those revenues come from outside of the U.S. A lot of those mega-cap names, the trillion-dollar club, are global players. They are multinationals. They are doing business everywhere. But you can invert this, right? So, our European equities index gets about a quarter of its revenue from the U.S. market. Our Japan index gets about 16% of its revenue from the U.S. market as well. And if you look at some of the companies, Nintendo and BP and Siemens, they’re major players in the U.S., right? Novo Nordisk is one of the big beneficiaries of the weight loss drug trend that’s sweeping America. It’s a Danish pharmaceutical company. So, you could argue that you don’t have full exposure to the U.S. market from a revenue perspective unless you have a global portfolio.

Bonds and International Markets

Dziubinski: That’s interesting. Now, Dan, we’ve seen the correlations between U.S. stocks and international stocks converge a little bit over, say, the past decade or two when they didn’t use to behave quite the same way as they are today. And we’ve seen on occasions some of that same divergence with bonds, but in general, the correlations have in general held for bonds. So, why is that? Why have those correlations shifted the way they have with international markets?

Lefkovitz: Yeah. Well, first, I think we have to acknowledge that the relationship between assets is always in flux. We assume that stocks and bonds are negatively correlated, but last year we saw both of them plunge in tandem. But it’s certainly the case that stocks in the U.S. and outside of the U.S., at the end of the day, there are shares of businesses that are often responding to the same sort of stimuli, whether it’s macroeconomic or at the sector level or capital flows. I think as economies have become more intertwined, as markets have become increasingly interconnected, it’s not surprising that we’ve seen correlations converge. But just because stocks in the U.S. and outside of the U.S. are moving in the same direction doesn’t mean that the magnitude of those movements is the same, right? So, an investor would have gotten very different results depending on their geographic allocation within their equity portfolio in recent years, and it can work both ways. So, 2000 to 2010 is referred to as the “lost decade” for U.S. equities. It wasn’t a lost decade for equities outside of the U.S.

The Strategic Value of Owning International Stocks

Dziubinski: Interesting. So, then, what would you say, Dan, at the end of the day, what is the strategic value of U.S. investors owning international stocks? Again, maybe the diversification isn’t there, but what’s the argument in favor of it?

Lefkovitz: I think, to me, it’s really about casting the net as wide as possible, opening yourself up to the full spectrum of opportunities. There are unique companies based outside of the U.S. There are certain industries or growth trends that you really only get full access to through a global portfolio. I’m thinking about growth in certain emerging markets or luxury goods or the mining of minerals that are critical to the clean energy transition or even structural reforms in corporate Japan. There are great companies that are based everywhere that Morningstar equity analysts consider to have economic moats or competitive advantages around their businesses. Many of them derive their revenue from outside of their home market, and many are trading at compelling valuations currently versus their U.S. counterparts.

Dziubinski: Dan, thank you so much for your time today, for helping make the near-term case and give us the long-term rationale for investing in international markets. We appreciate your time.

Lefkovitz: Thank you so much for having me, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “Midyear Market Checkup: ‘Unusual’ Stock Rally and Today’s Sticky Inflation” for more market updates.

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