Investors who witnessed a severe global stock market shudder during the first full week of trading in 2016 may well be considering which investment area offers the best opportunity with the least risk for the coming year – the U.S. equity market or international stocks. A case can be made for at least increasing global diversification in 2016, as analyst forecasts for U.S. stocks are generally more pessimistic than they are for international stocks, including both emerging-market economies and developed economies in Europe.
One good reason to look at increasing the asset allocation in your investment portfolio for international stocks is the simple fact that the economy is increasingly global. Between 2001 and 2014, the percentage of global gross domestic product (GDP) accounted for by the United States declined from approximately 33% to 22%. Nearly 80% of all publicly traded companies in the world are now headquartered outside the United States. The major shift in investments during 2015 reflects this reality, with international stock funds seeing a net inflow of over $200 billion from investors while U.S. equity funds saw more than a $50 billion drawdown in investment assets. That's over a quarter of a trillion-dollar shift in favor of international stocks in the space of just one year.
The U.S. Equity Market for 2016
U.S. stocks have undeniably enjoyed a bull run since the 2008 financial crisis. That very fact, coupled with the Federal Reserve's decision to raise interest rates, is one of the main reasons that many analysts are making less than rosy predictions for the U.S. equity markets in 2016. Many stocks are at extremely high valuations in relation to earnings. The S&P 500 Index is trading at 17.2 times earnings for 2015, significantly above its 14.5 average from 2005 through 2015.
Estimates for the eventual 2016 U.S. stock market performance range from Goldman Sachs analysts' predictions of a 4% gain for the S&P 500 Index to Deutsche Bank's more optimistic forecast of an 11% rise. However, any number in that range would still qualify as a drop in performance, since the average yearly gain for the period of 2009 to 2014 was 15%.
The Case for International and Emerging Markets
The stocks of many companies in emerging-market economies that have been popular with investors, such as Brazil, have significantly underperformed over the past couple of years, largely due to falling basic commodity prices. Many market analysts offer the opinion that prices for oil, precious metals and other components of the basic materials sector are likely bottoming out and poised for a rally to the upside. The fortunes of a number of key emerging-market firms could easily see a positive turnaround in 2016. Despite disappointing performance in the past couple of years, between 2003 and 2015, the MSCI Emerging Markets Index has shown a total increase of 172%. That's nearly twice the 96% rise in the S&P 500 Index over the same time period.
In developed nations, many countries in the European Union are still pushing hard to stimulate their economies at the very same time that the United States has begun a tightening monetary policy. A sustained uptrend in the U.S. dollar versus all of the major European currencies threatens to put downward pressure on U.S. exports while favoring European-based companies, such as Nestle and Daimler. European stock prices may have already factored in a recession – and may also have been unreasonably pessimistic in doing so. Strong European firms such as Credit Suisse and Sanofi may represent value-investing plays that could show investors double-digit returns in 2016.
A reasonable review of the global economic landscape may well lead investors to consider allocating a larger part of their total investment portfolio to international equities. Doing so will make their investments more appropriately diversified -- more reflective of the growing trend toward a global economy and the decline of the United States from its position as the world's overwhelmingly dominant economic power.