An International Market Update

At Gradient Investments we believe in diversification between asset classes (example: stocks and bonds), but also diversifying within each of these asset classes. There are a variety of factors to consider when looking to diversify within an asset class, including size, style, and geography.

Geographic diversification means selecting stocks from different regions. Globalization has created some confusion for investors over what constitutes an international stock. An international stock is not a US-based company with international revenues, but instead a company that is based in another country. Companies, even those with global revenues, tend to follow the economic trends of its home country and, more broadly, that region. As a result, it is important for investors to not only understand what is happening in the US economy, but what is happening within the global economy as these trends can have a significant impact on the overall portfolio.

International markets are composed of two main geographic regions: international developed and emerging markets. International developed countries are those found in Europe, Japan, and Canada for example, whereas emerging market countries would include China, Brazil, and India. Depending on what is happening across the globe, investors can see a significant differential of performance between these regions. The chart below shows the relative performance of US stocks compared to EAFE, or international developed, stocks. The data reflects that, over long periods, there can be significant performance differentials between the US and international markets.1 The most current trend, favoring the US, has been very long and quite a large difference. This has caused many investors to wonder why they own international stocks at all, given that diversification to international markets have been a drag on returns.




Those that have international exposure in their portfolio might know that global stocks have had a difficult year in 2022 and have underperformed US stocks. International Developed stocks are down 23.44% this year while Emerging Markets are down 23.37%.2

This is mainly due to rising global inflation post-pandemic, having emerged from supply constraints and incremental demand. These issues have only been exacerbated by the war between Russia and Ukraine. Russia is one of the largest exporters to countries in Europe, and the global conflict and subsequent sanctions have put the supply of oil into disarray for that region. Additionally, Ukraine is a large producer of grains, and the conflict has negatively affected their production and logistics, exacerbating higher food costs. Lastly, China is the largest emerging market, and multiple COVID lockdowns have had a negative influence on the supply chain as well as their own internally driven demand.

While the US markets have outperformed over the past few years, maintaining an international allocation is still an important aspect of diversification. The chart below illustrates that without owning any international equities you would have missed out on higher performance in 3 out of the 5 decades listed below.3 By introducing an international allocation to your portfolio, you can diversify the sources of long-term return, potentially lower portfolio volatility, and reduce concentration risk within the overall portfolio.




At Gradient Investments, the ETF Endowment Series portfolio is a globally diversified portfolio that incorporates both US and International stocks. In that portfolio, we are currently overweight domestic stocks and underweight international stocks. This allocation is based on the opinion that US markets will grow faster than their international developed counterparts, especially in Europe. While we are underweight, the Endowment Series has not fully eliminated international stocks from our portfolio. Our goal is to allocate to maintain diversification but also actively manage to have a higher weight towards regions for which we have higher conviction. We believe in owning international stocks in the portfolio, however, and as time progresses, we would look to change allocations or weighting as opportunities were presented.

Sources:

  1. JPMorgan Asset Management: Guide to the Markets 9/9/2022
  2. StockCharts 9/16/2022
  3. IFA Diversification Chart 9/16/2022