There is more and more proof that foreign stocks will do better in the future than U.S. stocks.
As you might expect, people have been saying for years that foreign stocks would rise again, but most of the time, they’ve been wrong. Non-U.S. stocks have fallen behind U.S. stocks so far this year and over the last one, three, five, ten, and fifteen years.
But the U.S. stock market will not always be the best. Brian Chingono, head of quantitative finance at Verdad Advisers, has calculated that U.S. stocks now make up 70% of the market value of all the stocks in the world’s developed economies put together. That’s almost twice as much as what was given in the 1980s. (For background, the chart below shows the U.S.’s share of all global stocks, not just those in developed countries.)
It would make sense for the U.S. to have a much larger share of the world’s equity allocations if the total earnings of U.S. corporations were equal to the total profits of all publicly traded companies in developed countries. They don’t, though. Chingono says that U.S. companies have only made up 55% of the total net income made by developed country corporations over the past year. This is a big difference from their 70% market-cap share.
Chingono agrees that this doesn’t necessarily mean that U.S. stocks are too big of an investment. If the earnings growth rate for U.S. stocks was higher than that for non-U.S. stocks, then the present 70% allocation could be okay.
But it doesn’t look like U.S. stocks will grow that much faster. Look at the PEG ratio, which is found by dividing the P/E ratio by the growth rate that is expected. The PEG ratio is a rough way to tell if the earnings growth rates of U.S. stocks are high enough to support their higher allocation. This means that the S&P 500 is 31% more expensive than developed country stocks outside the U.S. based on State Street’s estimates of EPS growth rates over the next three to five years.
What could bring down the sky-high prices of U.S. stocks? As Chingono points out, the U.S. market is clearly weak because of all the talk about AI. “Growth stories can change quickly when the economy gets tight,” he wrote in an email. “We can see this already with automakers cutting back on their plans for electric vehicles.” “A similar flip-flop could happen with AI, bringing down the value of stocks in the tech sector, which makes up more than 31% of the S&P 500.”
Another reason you shouldn’t put 70% of your global stock allocation in the U.S. is that analysts often get it wrong when they try to guess which companies will grow faster or slower over the next few years. Take a look at another Verdad study of Nvidia’s NVDA -0.03% growth rate in the future. It looked at the average earnings growth rates over the next five years of two groups of companies: the 20% of companies whose earnings grew the most recently and the quintile of companies whose earnings grew the least. The people who wrote the study said that there was no difference and that when experts value companies, they “might as well plug in the same long-term growth assumption for a software company as when valuing a coal miner.”
How to buy stocks in other countries
What would be a better way to divide up the U.S. shares in a foreign stock portfolio? Chingono advises that we give U.S. stocks the same share of our money that U.S. companies make of all corporate income around the world. In stock markets in rich economies, that means a 55% allocation instead of a 70% allocation.
To do what he says, you can’t just invest in one global equity index fund. Instead, you will need to use your chosen allocations to put money into different U.S. and non-U.S. index funds. A big index fund that invests in stocks from developed economies other than the U.S. is the Vanguard FTSE Developed Markets ETF VEA 0.27%. According to Vanguard, this fund is based on a “diversified group of stocks of large-, mid-, and small-cap companies located in Canada and the major markets of Europe and the Pacific region.” The cost of investing in it is 0.06%, or $6 for every $10,000 you put in.
If you want to buy individual stocks, the table below shows all the stocks with headquarters outside of the U.S. that are currently suggested for purchase by at least one of the investment newsletters that my firm checks. American buyers are already familiar with some of these 27 names, such as Honda Motor HMC 0.10%, Lululemon Athletica LULU 2.54%, Medtronic MDT 0.00%, and Volkswagen VWAGY 2.74%.
