US stocks won’t always outperform

Harry Markowitz’s work on the benefits of diversification may have revolutionised finance, but a truly diversified portfolio is a global one – a message that appears to have fallen on deaf ears in the United States.

AllianceBernstein recently noted international stocks account for just 15 per cent of US investor assets. Such home bias is not confined to retail investors – both Warren Buffett and the late index fund giant John Bogle suggested American investors will do just fine in coming decades by sticking to the US market.

A US-centric approach certainly worked out well over the last three decades, according to a recent Journal of Portfolio Management piece co-authored by AQR money manager Cliff Asness. Asness notes that since 1990 US stocks have outperformed their international counterparts by a “whopping” 4.6 per cent a year.

Valuation was the main driver over this period. In 1990 US stock valuations were about half that of the EAFE, an index tracking developed markets outside the US. By the end of 2022, however, US valuations were 1.5 times EAFE. Once you control for this change in relative valuations the US return advantage falls to statistically insignificant levels.

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Put simply, US stocks outperformed because they got more expensive over time relative to their non-US brethren. Betting on a repeat performance looks risky to say the least. International diversification has been a “losing experience for a generation” of US investors, says Asness, “but the long-run case for it remains relevant”.