Wall Street’s Wall of Worry
Stocks remain stoic, grinding steady gains through the summer.
Despite rising infections due to the delta variant, geopolitical concerns, inflationary pressures, and supply chain bottlenecks, stocks continued their unrelenting march to record highs.
Domestic stocks finished in positive territory, gaining for the seventh consecutive month. The S&P 500 notched twelve record highs, returning 3.0% in August. The index has more than doubled since the March 23rd low of last year. Even more, it has not suffered a 5% correction since last October.
While large domestic stocks led, gains were broad-based in a sign that the recovery in the economy and profits is robust. Shares of smaller companies and international markets added to already strong year-to-date returns.
The market’s smooth ascent looks out of step with reality. But, investors and the private sector, accompanied by a strong economic backdrop and central bank support, are learning to live with the virus.
Corporate earnings have trounced estimates to date as economies continue to reopen, and corporations have remained resilient in the face of price input pressures. Strong earnings, increased liquidity, and low interest rates are supporting historically high valuations for stocks.
Jerome Powell’s August 27th speech at the Jackson Hole virtual symposium was closely watched. The Fed insisted that it would continue to purchase debt securities until “significant progress” is made in employment. At the moment, it appears that any tapering of purchases will be gradual, transparent, and approached with caution. Further, inflation has already increased quite steadily above the Fed’s target rate. However, the Fed has insisted that it is likely temporary, signaling that future short-term rate increases are not likely in the near term. Thus, surprises from the Fed seem unlikely.
Historically, September has been a volatile month for the financial markets. Market activity will likely pick up from its summer lull. Investors will continue to focus on economic activity, China’s regulatory crackdown, and central bank guidance. The delta variant hangs over the financial markets like a dark cloud. So far, the focus has been on the positive effects of vaccines over the risk of variants slowing the recovery, but the extent of the impact on future global growth due to the delta variant and any possible future variant remains uncertain.
WHY BOTHER WITH INTERNATIONAL STOCKS?
For the past 14 years, there has been a wide discrepancy in performance between U.S. and international stocks. Year to date, U.S. stocks have continued this trend, outperforming their international peers by 8.6%.
For perspective, according to the World Bank, there are 43,248 publicly traded companies in the world, and 4,266, or about 10% of those, listed are U.S. companies. Even more, U.S gross domestic product (GDP) accounts for about 25% of global GDP.
But when weighted by market value, a global portfolio of stocks consists of about 60% domestic and 40% international. Cleary, large U.S. companies, primarily in the tech sector, have grown to dominate a large part of the global market.
With the global market increasingly concentrated in select U.S. companies, we believe international markets are more important than ever. Here is why:
Geographical diversification. Stocks in different countries behave differently. Shocks to one part of the world may miss, or benefit, another. Owning stocks domiciled in multiple countries reduces the risk any one stock market performs particularly poorly.
Many large, economically important companies are domiciled outside the United States. Companies such as ASML Holdings, Alibaba, and AstraZeneca are all international companies that are missed when focusing on domestic stocks. In many cases, these companies can be bought at more attractive valuations than domestic competitors.
Currency diversification. With significant business activity abroad, international stocks can maintain value if the dollar were to decline. Exposure to international currencies adds another layer of diversification and return potential.
Economic diversification. International markets tend to be concentrated in economic sectors that differ from domestic markets. For example, the U.S. is growth oriented and weighted towards technology and health care, while international developed markets are tilted more towards cyclical sectors such as financials and industrials.
Future Growth Potential. Emerging economies, those countries with low to middle per capita income, have better growth prospects relative to developed markets. According to the International Monetary Fund (IMF), emerging economies are expected to grow two to three times faster than developed economies in the future.
WHAT IT ALL MEANS
It can be a challenge to stay grounded when the market does unexpectedly good (or bad) things. For stock investors, we continue to advocate for a portfolio of globally diversified stocks that can reap the rewards of global growth and innovation.
For nearly a decade and a half, domestic stocks have delivered sizable gains relative to international stocks. Growth stocks, specifically mega-cap tech names, have been the primary driver of the outperformance and now have an outsized impact on domestic indices.
While the United States will continue to play a vital role in global markets, international markets are leading in innovative segments such as renewable energy, business-to-consumer technology, and automation. Also, international markets are more aligned in cyclical sectors, which should continue to benefit from the global economic recovery. In today’s market, owning international stocks can reduce the concentrated risk in a U.S.-centric portfolio.
As always, we are here to help you evaluate your investment portfolio and discuss your financial situation. Please do not hesitate to reach out if you have any questions.
Contact us at 865-584-1850 or info@proffittgoodson.com
Please see disclosures
