U.S. stocks are flying into record territory every day. The S&P 500 opened 2018 with six-straight sessions of gains, jumping by 2.7% for its best start to a year since 1987. The iShares Core S&P 500 ETF (IVV), which tracks the index, pulled in close to $1 billion so far this year, making it one of the most popular funds among ETF investors.
Investors are understandably optimistic about U.S. stocks. There are plenty of reasons to be sanguine on the market, even after the sizzling rally of the past year. Tax cuts are set to boost earnings; small business confidence is at a record high; and economic growth may be poised to finally tick up meaningfully from the subpar levels it’s been at since the financial crisis.
But even with that rosy backdrop, U.S. stocks may not be the best place for investors to be. International stocks, which handily outperformed their U.S. counterparts in 2017, are doing it again so far this year thanks to strong fundamentals of their own.
The $24.4 billion Vanguard FTSE All-World ex-US ETF (VEU) gained 3.2% in the year-to-date period through Jan. 9, compared with the 2.7% return for the U.S.-focused Vanguard Total Stock Market ETF (VTI).
Broadest Expansion In A Decade
According to analysts at Charles Schwab, the rally in international stocks is no fluke. Jeffrey Kleintop, chief global investment strategist at the firm, says that underpinning the rally is economic growth that is “exceptional.”
In a report published on Jan. 8, he said the world is seeing the broadest economic growth in a decade. Kleintop added that each of the 45 major economies tracked by the Organisation for Economic Co-operation and Development (OECD) is expanding, which provides a cushion for markets should one or two of them struggle in the future.
“While risks from politics, central bank policies and military threats haven’t gone away, investors have recognized that the global economy isn’t as vulnerable to these influences as it was during the prior decade,” he wrote. “Like a giant cluster of balloons, one or two could fail and the world’s economy would remain aloft for 2018.”
The OECD projects the global economy could expand by 3.7% in 2018, while analysts at Barclays believe the growth rate could hit 4%, which would be the fastest pace since 2011.
“The ongoing economic expansion has substantial momentum,’’ Barclays analysts recently wrote. “It is not overly reliant on any single geographical region, industry or source of demand.”
Great Time To Diversify
With a recovery so broad, it may be an opportune time for U.S. investors, usually heavily allocated to domestic stocks, to diversify. That’s especially true since correlations between different stock markets are at the lowest level in two decades, according to Schwab’s Kleintop.
“The return to the lowest average correlation across stock markets seen in 20 years implies globally diversified investors may benefit from less volatility without sacrificing return on the path to their financial goals—in essence decreasing risk without decreasing return,” he said.
For those interested in a one-stop-shop type of product, the $10.9 billion Vanguard Total World Stock ETF (VT) or the $9 billion iShares MSCI ACWI ETF (ACWI) fit the global bill. Both hold a broad basket of stocks covering most developed and emerging markets.
For investors who already have a core allocation to U.S. equities, a fund like the Vanguard FTSE All-World ex-US ETF (VEU), which excludes U.S. stocks, may be more appropriate to prevent overlap.
For others who want to manage their exposure in a more targeted way, there’s plenty of region-specific or country-specific ETFs that can help with that (use ETF.com’s screener to explore different options).
Correction Risk Lurks
Even though the outlook for international stocks sounds promising, investors should be mindful of the risks. Just like U.S. stocks, overseas equities have rallied uninterrupted for months, which makes them susceptible to a potential pullback at some point this year.
According to Goldman Sachs, the MSCI World Index is currently in the midst of the longest streak ever without a 5% correction. At the same time, the MSCI Emerging Markets Index is experiencing its longest stretch without a 10% correction.
None of this means that a sell-off is imminent, but it suggests many investors could be caught off-guard if equities suddenly began heading the other way.
Sumit Roy can be reached at [email protected]