#3: Overweight International Stocks
This recommendation, like investing in dividend stocks, is not exactly a perfect hedge. In addition to regular equity risk — beta, if you will — you also introduce currency risk into the mix.
Still, I’m OK with this for two reasons.
First, there is valuation. As I wrote recently, overseas markets are, for the most part, significantly cheaper than the American market. As measured by the cyclically adjusted price/earnings ratio (or CAPE), the United States is the second-most expensive market in the world today, second only to Sri Lanka of all places. Now, to be fair, the U.S. market probably deserves a premium valuation over the rest of the world given its high reporting standards and its liquidity and breadth. but it shouldn’t be nearly double the level of the U.K. or France, which is where it is today. The U.S., U.K. and France sport CAPEs of 25.44, 13.61 and 14.04, respectively.
Diversification is important too. Even without the yawning valuation gap, investors should keep a decent-sized chunk of their portfolio in nob-U.S. assets. We live in a global economy, and U.S. stocks only make up about a third of global market cap.
One reason that U.S. stocks outperformed last year was a belief that the U.S. economy was the “cleanest dirty shirt.” Growth here wasn’t great, but it looked better than Europe and most emerging markets. While these conditions are still true, it’s hard to believe that they are not already priced in. Meanwhile, Europe and emerging markets beckon …