3 Keys To Int’l Stocks Beating US

Here are three reasons underperformance by international stocks versus U.S. is unlikely to continue.

It’s been a rout—U.S. stocks have trounced international stocks over the past decade.

For the 10-year period ending Oct. 1, 2019, the Vanguard Total Stock Market ETF (VTI) returned 13.28% annually. By comparison, the Vanguard Total International Stock ETF (VXUS) would have returned about 4.78% a year. This fund didn’t exist for the entire 10-year period, so I’m using the benchmark it followed.

Why did international so badly underperform? I think there are three reasons, and all three are unlikely to continue.

Dollar Surge Won’t Repeat

The dollar surged against foreign currencies. According to the Federal Reserve Bank of St. Louis, the dollar surged 27.8% over the 10-year period ending Sept. 25, 2019 (latest available data). The dollar fell by roughly this same amount earlier that decade. The dollar is back to where it was at the beginning of this century for major currencies like the euro and Japanese yen.

Tech Will Cool

Tech was hot, and the U.S. has far more tech. Over the past 10 years, the Technology Select Sector SPDR Fund (XLK) returned a spectacular 16.61% annual return. Technology represents about 26% of the U.S. stock market, while it represents only about 12% of international stock. Nothing stays hot forever.

Value Proposition

Value was out of favor, and international has more value. There are multiple ways of measuring value. Two often used are price to book (PE) and dividend yield.

VXUS is far more value under both definitions. VTI has a PE of 3.12, while VXUS is less than half, at 1.52. VTI has a dividend yield of 1.85%, while VXUS yields 3.22%. Vanguard shows 10-year index returns of 14.45% annually for growth, while value returned 12.14% annually. Though I’ve never been a smart beta proponent, I don’t think smart beta will continue to underperform as it has so badly, especially over the past five years.

Regression to the mean is a powerful force. It doesn’t always happen, but few trends happen into perpetuity. The U.S. dollar, tech and “dumb beta” will not always be hot.

It would appear that the recent decade has proven the late John Bogle right in his advice to avoid international. On the other hand, both Vanguard and Fidelity have increased their recommended international stock holdings to 40% of global stocks.

I personally have about a third of my equities in international, and believe that capitalism works across the globe. While I can’t predict when international will outperform the U.S., I can predict that investors will increase their international stock allocation after it has outperformed.

My advice to clients is to pick an allocation to international stocks and stick to it. That’s more important than deciding on the actual allocation.

Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.