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Why Bother Investing Abroad?

Why Bother Investing Abroad?
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International investing may seem unwise in light of global volatility. We discuss why you should consider investing abroad and what you may overlook if you invest only in the U.S.

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RICK KARR:

Whether it’s war in Ukraine, economic strife in Europe, a pandemic in Africa, events abroad can rattle the markets. So it’s no wonder when stories like that are dominating the news, you start to hear the drumbeat of, “invest in the U.S.” But is keeping your investments closer to home really a better idea? What are you missing when your portfolio skews domestic? 

This is the Insights & Ideas podcast, brought to you by Charles Schwab. I’m Rick Karr, and we’re putting home-court bias to the test with Jeff Kleintop. He’s Schwab’s chief global investment strategist, which means he keeps an eye on events and trends around the world and figures out what they mean for investors. Jeff, good to talk to you.

JEFF KLEINTOP:

Thanks for having me. It’s great to be with you.

RICK KARR:

You and I were talking before we got in the studio. You said a lot of these events are irrelevant to investors, but some are relevant. And you have an analogy you like to use to tell them apart. I wonder if you could give that to our listeners.

JEFF KLEINTOP:

Well, that’s right, Rick. It is important to separate these events, because there’s always something going on—and if you put too much emphasis on everything, well, you’ll just get paralyzed. I like to think about the global economy and markets like the world’s oceans. They’re always in motion, they’ve got all kinds of different things interacting with each other, and they connect us all.

When you look at the ocean, you’ve got waves, you’ve got tides and you’ve got currents. That’s what moves the oceans around. And in a similar way, we’ve got volatility in the markets, we’ve got economic cycles, and long-term trends are what move the economy and the markets. Now, waves are the things that we get distracted by, that are constantly in the headlines. Things like the Ebola threat, or the conflict in Ukraine. These are potentially really impactful, but they’re low-probability events. Just like a wave. A wave has this big sudden surge, and then the water goes right back to where it was.

And so, we often get these short-term volatility moves, but then they don’t really go anywhere. Now, on the other hand—tides, like economic cycles, they’re harder to see with the naked eye. You can measure them over time, and that’s what we like to do in the markets with the economy—we like to measure it over time. Week after week, month after month. We measure those carefully, because when the tide turns, it can have a huge impact on the markets.

Tides can rise and a bull market can move higher for years, and it can go the other direction as well. Now, finally, currents—I mentioned, well, they’re almost invisible. You can’t really see those with the naked eye at all. But they move water vast distances over the long term.

These are things in the markets like demographic changes, or the steady march of technology and innovation. These all can have dramatic impacts over the long term—that’s through the waves and the tides. So Rick, that’s one way to think about the markets, and help separate the events that impact it.

RICK KARR:

You talk about the world’s oceans. Isn’t it just one ocean? And what I’m getting at here is, aren’t we talking about events that could have an impact here? How interconnected is the world right now?

JEFF KLEINTOP:

It’s funny that you ask that question, because I’ve actually seen this in a very visual way. So I was watching the Masters Golf Tournament here, back in April. And it was amazing to me. I went, actually, on the Masters.com website and I saw all the names, and next to all the names were all the little flags of the countries the golfers were from. And my brain just works this way, Rick. I looked at the flags, and I said, that looks a lot to me like the world stock market.

RICK KARR:

You built a spreadsheet, didn’t you? You put it all into a spreadsheet, didn’t you?

JEFF KLEINTOP:

I had to go to Excel. And I fired it up ... 

RICK KARR:

You’re a man after my own heart.

JEFF KLEINTOP:

And sure enough, that’s what we saw. You saw almost the exact same breakdown of golfers from around the world—including from the emerging markets: 16 percent of the golfers in the Masters were from the emerging markets. And guess what? We’ve got about that same percentage in terms of the world stock market. So it’s really interesting to see how far globalization has gone.

RICK KARR:

As goes professional golf, so goes the world economy, and so go the markets around the world?

JEFF KLEINTOP:

Well, sure. I mean, there’s no avoiding exposure to global markets. We got nearly half of the revenues of the U.S. companies in the S&P 500® Index—those revenues come from outside the U.S. So they’re already global. Global economic conditions drive demand, they drive interest rates, input costs and many other factors that drive U.S. markets.

The upshot of all this is that the stocks of companies all around the world now behave more like other companies in their sector. For example, a tech stock in the U.S. behaves just like a tech stock in Japan, pretty much. Wherever they’re based, they tend to behave like the industry they’re in, more like their home country. There are a lot of ways we can measure that, but that’s something that we’re increasingly seeing more and more of.

And even if you wanted to avoid owning non-U.S. companies, well, you’d be unable to avoid global exposure, right? Because even U.S. companies certainly have a lot of exposure overseas, either directly or indirectly. And the benefit of that, the benefit of thinking globally, of not trying to insulate yourself from the world, is that you’ve got a wider opportunity set. Allocating outside the U.S. to global companies certainly opens up a much larger universe of companies that can help manage volatility and perhaps get you some better performance, too.

RICK KARR:

Jeff, a lot of the events we’ve talked about so far are outliers. And lots of other factors really do affect economies. So if I see potential in growing markets, what should I be looking out for? Where should I turn to get the information? How do I tell the tides from the waves from the currents?

JEFF KLEINTOP:

There are a lot of things I like to look at. And I guess if I had to point to one, most important thing, I really like to watch the monthly Purchasing Managers’ Index. Now, this is a survey of purchasing managers at manufacturing firms. They’re kind of on the front line when orders come in. They see it first. And they order the supplies, and they coordinate the materials as it goes through the manufacturing process.

And their responses are all scored. And they’ve been doing this forever. I’ve got them on the wall of my office at home. A copy of the Wall Street Journal from October 1929, you know, right before the big crash. And it references this survey. So it’s been around a long time. And I like to watch it. They do it across many countries now. It’s a great indicator. It usually gives you a few months or a few quarters of heads-up, that a change in the tide might be coming, particularly as it relates to earnings. So I do like to watch that pretty closely.

Another one is the OECD, and they produce a comprehensive, leading indicator of economic activity. And this is made up of a number of different things. But it usually does give a good heads-up when the economic tide in a country might be nearing a turn.

And then, finally, I like to look at the yield curve. You know, it sounds complicated, “yield curve,” but it’s actually really simple. You just take long-term interest rates and subtract short-term interest rates. It really couldn’t be easier. When the gap between the two shrinks, or even turns negative, that’s when you want to watch out.

Usually, that’s a really good indicator that we’re about to see a turn of the tide—that a recession might be on the horizon. That’s worked seven out of seven times here in the U.S. in predicting a recession. So that’s another one I like to look at. Those indicators are really good in terms of giving you a heads-up when that tide’s about to turn. You can kind of look past a lot of the waves and maybe focus on some of these measures of the economic tide.

RICK KARR:

There’s one thing that we haven’t talked about yet. And it might be a wave, or it might be a tide. But it has struck the U.S. And that is terrorism. Does it affect the economy, and if so, is there any way an investor can get a little insulation from the effects of it?

JEFF KLEINTOP:

A major terrorist attack that disrupts economic activity and raises security fears is always a risk for the capital markets. I mean, the human toll is immeasurable. And the impact of terrorist attacks will stay in our hearts and minds long after any economic cost is recouped.

But as it relates to the markets—unfortunately we’ve got many thousands of terrorist attacks to look at over the last 30 years. And what we’ve found is, major acts of terrorism have not had a lasting, long-term negative effect on financial markets. In the countries where the attacks occurred, the stock market fully recovered, usually within a week.

And actually when we include the London Stock Exchange bombing back in 1990—and there was a recession that followed that—that upped the average to four weeks. But still, not a long period of time. So, with the exception of maybe the 9/11 attacks, there’s never really been a terrorist attack that’s had material negative economic effects. That’s not to say it couldn’t happen. But it’s certainly something that’s extremely rare, and not something I think you need to generally worry about on a day-to-day basis in your portfolio. There’s always that risk that the first time it could happen. But, look, if the attack remains a tragic but isolated event, it’s unlikely to alter the market’s trend or change the economic tide.

RICK KARR:

The issue here, it sounds like you just need to keep a clear head, basically, is what you’re saying.

JEFF KLEINTOP:

I think it’s important to be able to separate. Look, we could make a long list of all the things that could possibly happen, right? Whether it’s overseas or here in the U.S., we mentioned terrorist attacks. But certainly things in China, negative political events, whatever they are. And we could get ourselves paralyzed, worrying about every possible thing.

I think we have to think about what’s actually more likely to happen. And maybe what we see show up in the measurable data that we can take a look at on a regular basis, some of which I’ve mentioned. I think that helps us kind of separate the waves from the tides, and keep us focused on what really matters most to us as investors.

RICK KARR:

Jeff, thanks for joining me.

JEFF KLEINTOP:

My pleasure. Thanks for having me. 

RICK KARR:

Jeff Kleintop works at Charles Schwab, keeping an eye on events and trends around the world, and figuring out what they all mean to investors. If you want to follow him on Twitter, his handle is JeffreyKleintop, all one word. That’s J-E-F-F-R-E-Y K-L-E-I-N-T-O-P. That’s it for this installment. The Insights & Ideas podcast is brought to you by Charles Schwab. You can find us on iTunes, or go to insights.schwab.com. Our producer is Matthew Nelson. I’m Rick Karr. Thanks for listening.

Important Disclosures

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. 

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