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2016 International Investing: Why Laggards Don't Necessarily Produce Winners

Key Points
  • Investing in poorly performing countries as a shortcut to finding value isn't a sound strategy.

  • This approach ignores several factors, including the impact of heavy concentration in one or two sectors; larger economic, demographic and political forces; and compounding economic factors.

  • In place of investing in countries where performance is lagging, we believe a diversified approach to investing can improve performance and reduce risk.

Does it ever make sense to invest in a country's stock market specifically because it has had a bad year?

With markets getting off to such a rough start so far this year, some investors may be on the hunt for buying opportunities among the global laggards. The idea is that focusing on the poorest-performing stock markets might be a shortcut to finding value. After all, picking up an asset after it tumbles can be a way to take advantage of any future rebounds.

Unfortunately, it's not that easy. Here's why.

Poor performers may not bounce

First of all, just because a country's stock market ranks among the worst performers in a given year doesn't mean it's destined for a comeback the year after. In fact, Schwab data covering the past 15 years shows that the worst-performing market in any given year often struggles the next year.

Among developed-country markets, a year at the bottom of the league tables meant continued weakness the year after 63% of the time. Emerging market stock markets fared slightly better, with one bad year leading to another 56% of the time.

Stretching the time horizon out didn't necessarily improve things. Among developed markets, 64% of losers continued to underperform over the following three years, while 43% of emerging market-losers lagged.

Developed-market losers underperformed 63% of the time the next year 

Developed-market losers underperformed 63% of the time the next year 

Source: Charles Schwab & Co. Inc., Morningstar, as of 12/31/2015. Individually named country performance data derived from associated MSCI NR USD indexes
*Relative performance measured against the MSCI EAFE Index. Returns are in U.S. dollars and assume reinvestment of dividends and interest. Past performance is no indication of future results.

EM losers underperformed 56% of the time the next year 

EM losers underperformed 56% of the time the next year 

Source: Charles Schwab & Co. Inc., Morningstar, as of 12/31/2015. Individually named country performance data derived from associated MSCI NR USD indexes
*Relative performance measured against the MSCI Emerging Market Index. Returns are in U.S. dollars and assume reinvestment of dividends and interest. Past performance is no indication of future results.

Sector concentration may stymie a rebound

Why do some countries' stock markets struggle? It could have something to do with the composition of the local market. Some countries' stock markets are dominated by particular sectors or companies. If those sectors or companies are in the doldrums, they weigh on the overall performance of a country's benchmark stock index.

For example, stock markets with high weightings in financials can be more closely tied to the economic outlook of the country, demand for loans, and the spread between short and long-term rates. The bust of Ireland's housing market and the resulting deterioration of fundamentals in the financial sector resulted in Ireland's stock market underperforming in both 2007 and 2008.

A country's markets could fall victim to large-scale global forces

A single company exposed to a fading industry can introduce new products, divest underperforming divisions and pursue mergers and acquisitions to transition toward growth markets. These changes can set the foundation for a rebirth in earnings growth for a company. However, reinventing an entire group of companies can be more challenging. For example, the slowdown in China's economy and rise in the value of the U.S. dollar have acted as drags on the economies of countries that are heavily dependent on commodity exports.

As China gobbled up metals, coal, and other commodities over the last two decades or so to fuel its infrastructure-building boom, companies around the world hustled to supply that demand. That left some countries' stock markets overly exposed to China's economy and therefore hurt by the shift in its economic model to a more consumer spending-oriented growth strategy.

These external trends often play out over several years. Countries that have a large portion of the economy—and by extension a large portion of the stock market—focused on a dominant sector can lack the diversification needed to adapt quickly to a changing global economy. Developing new industries and company leadership can involve educating and training a workforce, investing in product or sector development and cultivating the necessary supply chains, all of which take time.

Local politics can thwart a turnaround

Where some markets are dominated by the fortunes of a particular sector, others may be dragged down by entrenched political or economic forces.

For example, Brazil's economic woes have taken years to tackle. Attempts to stimulate the economy over the last several years only succeeded in worsening the country's budget deficit. And continued uncertainty about the deficit and stagflation—a period of low or no growth coupled with high inflation—has created a negative feedback loop that weakens the currency, prompting capital to flee, further pressuring the currency and stock market performance.

What can investors do?

Instead of looking to pick short-term winners, we believe international investors can benefit from a diversified approach to investing. Diversification is a key principle of investing: It can improve performance and reduce risk over time, both across and within asset classes.

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  • Call Schwab anytime at 877-338-0192.
  • Talk to a Schwab Financial Consultant at your local branch.
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