International Investing: Just a Myth?

Suppose you received a letter from a financial advisor who told you that a certain stock was going up over the next several weeks. You watched the stock, and sure enough, it went up. A few weeks later, that same advisor sent another letter to say another stock was going to go down over the following few weeks. As you watched, the stock did go down. The advisor sends a third letter to tell you to watch another stock that was going to go up—and it did.

Then he sent another seven letters, each time correctly predictingthe direction of every stock he told you to watch—a perfect prediction 10 out of 10 times. In the eleventh letter, he asked for a big investment. What would you say? He was right ten out of ten times. (For related reading, see: Don't Buy What You Don't Understand.)

What the investor does not see is the total picture—the whole story. That financial advisor began sending letters to 10,240 prospects. In 5,120 of the letters he predicted that the stock would go up; in the other 5,120, he predicted the stock would go down. The 5,120 to whom he sent the letter saying the stock would go down never heard again from our financial advisor. Of the 5,120 to whom he said the stock would go up, 2,560 got a second letter predicting that second stock would go up and the other 2,560 got a second letter saying the second stock would go down.

The 2,560 who got the letter predicting the wrong direction of the stock? Those people never heard from our financial advisor again. Of those who got the correct prediction, 1,280 got the third letter predicting a third stock would go up; 1,280 got a letter saying the third stock would go down. And so on. (For more, see: 6 Questions to Ask a Financial Advisor.)

Get the Whole Story

You, reader, now have the full story. Only 10 prospects would get letters with 10 perfect predictions. The other 10, 230 people never heard from the advisor ever again. This is the classic Baltimore stockbroker story. Why Baltimore? No one knows. As far as I know, there never was such a stockbroker. But, I am sad to say, this illustrates what happens on Wall Street

One of the most touted marketing programs by Wall Street is diversification and improving portfolio performance through investing in international equities. In 2001, following the Dotcom bubbleGoldman Sachs Group Inc. came out with a report predicting that economic growth in four countries would be significantly greater than economic growth in the United States. There was logical reason to believe that growth in those places—Brazil, Russia, India, and China (BRIC)—would outpace economic expansion in the U.S. (For related reading, see: Brexit's Effect on the Market.)

The conclusions drawn then and even today are that those country’s stock markets are going to outperform the U.S. market. Maybe I am just cynical, but even at that time I wondered if this study was really about the stock markets or if it was a marketing ploy to get clients who had been burned by the Dotcom crash to invest again. Was it a ploy to say, “You got burned with dotcoms in the U.S., but you can invest with greater confidence in the BRICs.”?

Since that time we have had other studies—and even data from those BRIC studies—that raise many questions. The data for Brazil, for example were based on only 10 years of statistics. Credit Suisse analyzed the relationship of economic growth and stock market performance for 83 countries from 1972 to 2009. It ranked the countries by their pace of growth on five-year periods and looked at how the stock markets performed. Investing in the highest economic growth countries yielded stock market increases of 18.4% over the five-year period. But investing in the lowest economic growth countries yielded stock market increases of 25.1%. 

Finding Solid International Exposure

I do believe that the economic growth in those BRIC countries will be greater than the economic growth of the U.S. I have said that before and that is the driving force of the supercycle we are in now. But that is not the whole story. Just because there is greater economic growth does not mean the stock markets will do better than the U.S. market. I believe it also exposes the investor to greater investment risk. Consider what is happening in those emerging countries now—it's not pretty. On the other hand, “slow growth United States” has stock markets reaching new highs. 

I want international exposure, but I will achieve that by finding U.S. companies that have significant sales overseas. Like with the Baltimore stockbroker tale, I believe Wall Street is pushing its own agenda and most investors don’t get to see the whole story. The BRIC study is just one of a number of misleading marketing pushes I have seen over the years. Receiving ten letters correctly predicting the movement of ten stocks gives a rational and logical feeling that the Baltimore stockbroker is really knowledgeable and capable.

Getting studies from big brokerage houses and information from news outlets or magazines with rational concepts and investment themes seem reasonable. But what is the real agenda? What is the whole story? Be sure to ask yourself that before you hand over your money. (For related reading, see: Why Young Investors Should Become Market Agnostic.)