Faced with big US changes, should investors look abroad?

Stocks

Summary:

U.S. market volatility and Trump’s tariffs have investors questioning American stocks' dominance. International equities, seen as cheaper and more resilient, are outperforming, highlighting the importance of global diversification in portfolios.

US stocks melted down and market volatility soared after President Donald Trump announced his across-the-board punitive tariffs regime on April 2. While international stocks got hurt too, overall they’ve done better.

Sure, US stocks were considered overvalued coming into 2025. But the loss of trillions of dollars over a matter of days in April was extreme. And it wasn’t much comfort when stocks staged some mini-relief rallies on hopes that things might not be quite as bad as feared because Trump was postponing or lessening certain tariffs, or there were signs his advisers convinced him firing the Federal Reserve chair would be bad for markets and the economy.

Coupled with the decline in the value of the US dollar — long considered to be the world’s reserve currency — the negative economic effects of Trump’s tariffs are pushing investors to wonder if the US is still the strongest and safest bet relative to other countries.

So far, the answer to that question seems to be a very qualified “Yes, but …”

“People are still trying to figure out what’s happening,” said Amy Arnott, a chartered financial analyst and portfolio strategist at Morningstar.

As things stand, “both cyclical and structural changes to U.S. exceptionalism are now on the table, being priced at a greater-than-zero probability of weakening,” the global equity team at investment firm Wiliam Blair noted last week in a blog.

Looking abroad for value

There’s a question of whether US investors should allocate more — or just some — money to international equities.

Individual US investors typically haven’t had a lot — or even any, in some cases — exposure to stocks from countries with developed or emerging economies in their portfolios. And they haven’t suffered for it in the past decade. That’s because US stocks handily outperformed non-US stocks by as much as four to five percentage points a year, Arnott said.

But this year, the reverse may be happening.

The Morningstar Global Markets Index ex-US was up 6.46% year to date through April 24. By contrast, its US Markets Index was down 6.59%.

The reason is likely two-fold, Arnott said: International stocks are less expensive than their US cousins and there’s been heightened concern and uncertainty about US policies.

Over the next several years, Vanguard’s investment outlook, for instance, continues to forecast that international equities will outperform US stocks due to more attractive valuations.

Still, net money flows into US equity mutual funds and ETFs have remained positive year to date through mid-April, according to data from the Investment Company Institute, suggesting US equities remain an attractive bet overall.

Diversity remains a good hedge

However, this year has reminded investors why having a diversified portfolio is helpful when US stocks are dropping.

Consider the balanced model portfolio with 60% stocks and 40% bonds. Its best feature: a lower risk and volatility profile than portfolios more heavily invested in stocks.

Such a portfolio that only invested in US stocks for the equity portion was down roughly 3% year to date — much better than the bigger drops on US stock indexes. But if 20% of the stock portion had been in international equities, the portfolio would be down just 0.41%, Arnott said. “If you had international exposure, you would have done significantly better.”

Of course, US Treasuries have been on a scary trip too in the past month. Normally when stocks are plunging, investors pour into US government bonds, pushing their prices up and their yields down, because they’re buying safety — that they won’t lose money and that they will always be paid back. But in the second week of April there was a sell-off, pushing Treasury yields higher — and in the case of the 10- and 30-year bonds, yields have remained higher than they were on April 2.

Granted, it’s not the first time US bonds have bucked their reputation. See: Your portfolio returns for 2022.

The question is, will this remain a problem going forward? Answer: Who knows?

Much may depend on how the US and world economies adjust to the many trade wars that have been ignited, which economists warn will make US inflation worse and slow economic growth.

“In a scenario where we have inflation flaring up again, that could put pressure on stocks and bonds. So, holding a diversified portfolio with bonds and international stocks is not a magic bullet in every market. But it improves the odds that you’ll have some ability to withstand volatility,” Arnott said.

A path forward for now

If your prime exposure to the markets is through a retirement-year target date fund in a 401(k) or IRA, you may already have the diversification you need, especially when it comes to international equities.

That’s because for years, target date funds have been overweight in international stocks, said Jason Kephart, a senior principal of multi-asset strategy ratings at Morningstar.

Compared to all equity mutual and exchange traded funds, which aim to hold 25% in non-US assets, target date funds have allocated 30%, Kephart said.

That has started to pay off this year, Kephart said.“Diversification is finally being rewarded,” he said.

Similarly, a target date fund will make adjustments to the bond holdings in your portfolio, bumping up the allocation to a diversified mix of high-quality government and corporate bonds the closer you get to your target retirement year (e.g., 2030, 2040, 2050).

But if you’re not in a target-date fund and you are managing the asset allocation in your retirement account, you might consider having up to 35% of the stocks portion of your portfolio in non-US equities, Arnott said. That would echo how the MSCI All Countries World Index (ACWI) is weighted toward non-US stocks.

Or depending on your risk tolerance, you might follow the advice of Adam Grossman, a chartered financial analyst and founder of Mayport Wealth Management. In his latest weekly newsletter he suggests an allocation to international stocks “in the neighborhood” of 20%. “According to the data, that’s enough to deliver a diversification benefit, but not so much that it introduces significant currency risk,” he wrote.

Either way, you can get your exposure to non-US stocks through a low-cost world markets ex-US index fund. (Morningstar offers its pick of the top 10 here.)

As for bonds, Arnott suggests looking for a core bond fund for your 401(k) — which will be invested in different types of government and investment-grade corporate bonds.

If you’re investing in bonds on your own — say, for the portion of your money that you want readily available to draw on for living expenses when you’re in or near retirement — “Focus your bond allocation on the short- to intermediate-term portion of the yield curve. I would be very cautious with longer-term Treasuries. That is where the risk is greatest,” she said.

source :cnn

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