Déjà vu.

A US government shutdown was narrowly averted over the weekend. Members of Congress voted to extend funding for another 45 days, essentially kicking the can down the road. The threat of a potential shutdown — and worries about a prolonged period of higher interest rates — contributed to September losses across the board, down 4.9% for the S&P 500, 5.8% for NASDAQ, and 3.5% for DJIA. Overseas, the Stoxx Europe 600 declined 1.7%, Japan’s Nikkei 225 was down 2.3%, and the Hong Kong Hang Seng Index lost 3.1%. Despite the worst monthly performance so far in 2023, the S&P 500 is still up about 12% year to date, defying predictions of a recession earlier in the year.

A couple of weeks ago, I joined a panel discussion during the United Nations General Assembly (UNGA) and NYC Climate Week to discuss how we can leverage the power of capital to invest in solutions to make our world better and more equitable for everyone. During the panel, I spoke about the importance of a global mindset. Pressing social and environmental issues aren't just domestic problems; they affect every country on the planet. While you might feel that charity starts at home, solutions can and should cross borders, as what impacts a single country can simultaneously affect all countries. Today more than ever, global economies are intertwined through trade and shared interests. A rising tide can lift all boats, big and small. 

It’s no different when it comes to investing. A global approach should be part of a well-diversified portfolio. As US citizens, it’s too easy to invest with a home bias, the tendency to overweight domestic stocks over international ones. It's well-known in the field of behavioral finance that we gravitate toward what’s familiar and shy away from what’s not. This kind of bias influences all of our decisions — what we eat, who we hang out with, who we hire, where we travel. But when it comes to long-term investing, having a heavy home bias could mean missing out on both the benefits of diversification and potential returns.

Below is a chart that breaks down the world’s equity market capitalization as of Q2 2023 — aka the total value of all equity markets. The US stock markets represent 42.5%, less than half of the world’s markets. European nations represent 11.1%, and China alone is at 10.6%. By investing only in the US equity markets, investors are limiting themselves to less than half of the world’s investment opportunities. While you can have international exposure by investing in multi-national US companies whose revenues are driven by sales abroad, it’s not quite the same, and it’s not quite as diversifying. 

You might argue that the US market has been the strongest performer globally, and you'd be right … at least over the last decade. But the US market hasn't always been the top performer in any given year. Last year, developed markets outperformed US stocks by 4%. In 2017, emerging market equities returned 37.8% and developed markets returned 25.6%, compared with 21.8% for the S&P 500. And as economies grow, global market capitalization changes. In fact, the market share of emerging markets is predicted to exceed that of the US by the year 2075 due to higher projected growth rates for those countries. 

Another measure investors use to gauge the attractiveness of various markets is their forward price to earnings ratio (“forward P/E”). This metric divides a company’s stock price by its forecasted annual earnings, and indicates what investors are willing to pay for every dollar of earnings. It can be calculated for individual companies, as well as for stock indices, such as the S&P 500. The chart below shows these ratios for the US (S&P 500), for developed markets (MSCI EAFE), and emerging markets (MSCI EM) from 1995 to today. 

As expected, the forward P/E ratio for the US is higher than that for both developed and emerging markets, making international stocks appear cheap relative to US stocks. Investors have good reason to pay more for US stocks, given the strength and resilience of the US economy post-COVID. But how long will the party last?

Some experts believe international stocks are poised to outperform US stocks, reversing the trend of the last decade. Not only are international stocks attractive relative to US stocks, they also appear attractive from a historical perspective. On the chart above, if you drew a straight line from the ending point of each index across to the left, you’d note that US valuations are relatively high compared to where they’ve been historically; but developed markets — and particularly emerging markets — are still lower than their historical averages over this time period. So, international stocks aren’t just cheap relative to US stocks, but relative to where they’ve been. 

Emerging economies in particular are projected to grow faster than advanced economies, led by the growing middle class in China, India, Mexico, and other countries in Southeast Asia. China in particular trades at a P/E of only 10.8x. While its economic recovery has been hampered due to its strict Zero COVID lockdown, muted consumer spending, significant amounts of debt, and the recent implosion of property developer China Evergrande, it’s still the world’s second-largest economy. As such, its influence on global growth and its role in the global economy, supply chains, and trade can't be ignored. Experts are now predicting China GDP growth rates of closer to 3%, a much lower pace than the 8% average growth rate over the last two decades. That’s still faster than the US, which is forecasted to grow 2.2% this year and fall to less than 1% next year. 

As we often say, we don’t know what the future holds for the markets. The next decade could be a strong one for international markets, or US markets may continue to dominate. But if you stick too close to home, you’re missing more than half of the world’s investment opportunities, as well as the diversification benefits of international equities. Of course, investing abroad comes with greater volatility and different risks such as geopolitical shocks, currency risk, regulatory and regime changes, natural disasters, and political risks, to name a few. (I dare say we have our own special version of political risk right here at home as Congress continues to wrangle over government funding, debt, and budgets.) 

Diversification is truly the only free lunch in investing, and that includes investing across borders in international, developed, and emerging countries. Doing so through low-cost, broadly diversified ETFs and mutual funds, as we do at Ellevest, can help mitigate risks, while benefiting from potential long-term growth. 

If wealth management sounds right for you, connect with our all-women team of Ellevest Private Wealth Management financial advisors. Or read more about how we’re here to support you with all aspects of your wealth.