“Diversify globally.” If you’ve listened to that advice recently, a strong dollar and American tech leadership have caused your international stocks to underperform U.S markets. Now you need to decide:
- Will international performance improve?
- Should you continue to globally diversify?
To answer those questions, let’s first take a look at the path ahead for the dollar, before turning our attention to whether tech can continue to lead markets higher. We’ll then answer the Big Question: Should you continue to globally diversify?
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Where’s the U.S. dollar headed?
Since 2014, the MSCI EAFE, a popular index tracking large- and mid-cap stocks in 21 developed countries, is basically flat, in part because the index has been swimming against a rising tide. When a U.S.-based investor purchases foreign stocks, they must eventually convert foreign currencies back into dollars, so a stronger dollar hurts their returns. And since 2014, the Dollar Index is up more than fifteen percent.
However, there are at least a couple of reasons to believe that the dollar could start to weaken. First of all, the Federal Reserve has pegged short-term interest rates at zero and pledged to keep them there. The United States has also seen both the budget deficit and the national debt spike, which is currency negative. Finally, investors favor stability. While the U.S. still earns relatively high marks in that regard, recent social and political turmoil could cause some investors to reevaluate their exposure.
It looks like the dollar might be poised to weaken, which could remove a major headwind global investors have been fighting.
Will American tech leadership continue?
The biggest reason US markets have outperformed? It's simple: Better stocks. The tech sector, led by companies such as Apple (AAPL -0.20%), Amazon (AMZN 1.80%), Microsoft (MSFT 1.14%), and Netflix (NFLX -0.64%), has experienced rapid growth in recent years, and there are more tech companies in the U.S. than in many other countries.
For instance, the S&P 500 has a 27% weighting towards information technology (IT) and 11% in the communication services sector, which is now home to “tech” companies such as Facebook (META 0.90%), Alphabet (GOOG 1.31%)(GOOGL 1.25%), and Netflix. By contrast, the MSCI EAFE Index has only 8% in IT and 5% in Communication Services, so when tech companies lead the way, U.S. markets are well positioned to outperform their global peers.
But starting valuation and investor sentiment are two powerful drivers of future performance. Although tech has been leading the way, other sectors could eventually rotate into leadership positions. Many of those sectors fall into the category of value stocks, which have been shunned by investors in recent years and have witnessed their performance relative to growth stocks fall to some of the lowest levels on record.
This potential rotation could lead to big winners in the higher-weighted sectors of international markets. So if market leadership rotates from tech to sectors such as financials, industrials, and materials, international markets may disproportionately benefit by virtue of their greater exposure to these currently unloved sectors.
Should you continue to globally diversify?
If you're still evaluating international markets, ask yourself:
- Will the U.S. dollar weaken at some point?
- Will sector leadership rotate away from tech?
If the answer is “no,” then concentrating your portfolio in domestic markets might make sense. But keep in mind that reversion to mean, whether in currency markets or sector leadership, is one of the fundamental principles of investing.
If the answer is “yes,” then you’ll likely want to maintain some level of global diversification, even though doing so can be difficult when the U.S. is leading the way. It’s almost impossible to predict exactly when this tide will turn, but we can be almost certain: At some point, it will.
