Investing Globally: Can You Pick the Winners?
It surprises some people to learn that the equity markets in the United States, while certainly possessing the world’s largest market capitalization, include only about half of the world’s equity investments. This means that those who limit their investment in stocks or stock mutual funds to only those stocks traded on U.S. markets have access to only about half the equity investments available worldwide. Imagine shopping in only half of a supermarket or limiting yourself to only half of a well-balanced diet. Now, of course, for some investors, it may make sense to keep most investments closer to home, for individual reasons such as tax advantages. But for most investors who are trying to maximize their equity returns while limiting the overall volatility of their portfolios, some global diversification is usually a good strategy.
The problem is, the world of global equity investing can be pretty bewildering. There are about 15,000 publicly traded companies, located in more than 40 countries, worldwide. How is the average investor supposed to research that many different opportunities in order to find the best performers? For that matter, how can an investor even decide which countries’ stock markets offer the best prospects for returns in any given time period?
The answer, of course, is that you can’t. As a matter of fact, when you put global equity returns on a grid chart, with each column of the grid representing a year and each colored block of the grid representing a different country’s equities markets, the result looks something like a crazy quilt: there is no easily recognizable pattern. For example, take a look at the following chart, which shows each country of the world’s developed equities markets, ranked from highest to lowest annual return in each column and showing results from 1999 to 2018. Each colored block represents a different country.
Can you see a clear pattern? Neither can I. By the way, in the last 20 years, the U.S. equities market (represented by the royal blue boxes in the above chart) turned in the world’s top return only once, in 2014. It placed ninth overall, with an average annualized return of 4.9%. Want to know which country was the top performer? It was the one represented by the gray boxes: Denmark. Over the last 20 years, Denmark’s equities market led the world only once, in 2015. And yet, Denmark’s stock markets averaged an annualized yield of 9.1% from 1999 to 2018. And here’s an interesting fact: Denmark’s entire market capitalization, at $250 billion, is about a third of the value of the market capitalization of Microsoft Corp., at $750 billion. Obviously, an investor who could have predicted that Denmark would turn in the world’s best performance from 1999 to 2018 could have concentrated on Danish equities and significantly outperformed those investing in other countries, including the United States. But of course, no one could predict this.
In recent years, much has been made of the opportunities in emerging markets—countries with economies that are less mature than those of the developed nations, including places like Brazil, India, Russia, and, largest of all, China (the so-called “BRIC” countries). Analysts point out that, because the economies in these countries are still expanding to meet the needs of a growing middle-class population, companies operating there have greater opportunities for growth.
But even in the active emerging market equities sector, predicting which country will turn in the best performance in any given year, or even any given decade, is still practically impossible. Take a look at the grid chart representing emerging markets from 1999 to 2018.
Once again, it is very unlikely that anyone would be able to discern a pattern in these performance statistics. Hungary and Russia, the two best performers in 2015, were the two worst performers the previous year, in 2014. This just points out that accurately predicting the performance of a particular equity, or even all the equities in an entire country, is exceedingly difficult.
So, what should investors do? Rather than giving up on equity investments altogether, which would be a big mistake in most cases, investors should employ a strategy of broad diversification across many sectors and even across many countries. As we have seen, there is no reason to believe that U.S. equities, despite being the world’s largest market, will outperform other countries’ stocks in any given year. Investors who wish to reduce the overall volatility of their stock portfolios while still capturing higher average returns may benefit from diversifying their holdings, not only among U.S. equities, but also internationally.
When you think about it, the randomness of global equity returns also emphasizes the randomness of any given equity’s performance during a particular time period. If it is impossible to predict which country’s stock market will outperform in a given year, how much more difficult would it be to accurately pick the one stock—or even one hundred stocks—that will lead the market at a particular time? The answer, as decades of research demonstrate, is that no one can consistently “beat the market” over the long haul. And that is precisely why we recommend a program of diversified holdings, controlled transaction costs, disciplined rebalancing, and patiently sticking to a long-term strategy designed with the particular investor in mind. Rather than trying to predict the unpredictable, we recommend positioning investors broadly enough to benefit from a variety of market and economic outcomes, so that losses in one area may be offset by gains in another.
In today’s equity markets, it certainly pays to think globally. But it’s also essential, we believe, to think broadly.