1st Quarter 2025.
Market Review
Performance Driver Review
Market Perspectives
With the strength of the U.S. stock market the last several years (save for a challenging 2022), it has gotten easier for investors to feel their advisor’s recommendation to hold some international stocks is a crazy one. Let’s take a gut check—what’s pushed sentiment in this direction?
International stocks have broadly trailed their U.S. counterparts for over 30 years. Breathers occurred here and there following bubble bursts in the U.S., so at times the outperformance was lumpy, but the past decade has made for a prolific dispersion between home and abroad. This makes it very easy to point to U.S. exceptionalism and assume an all-U.S. allocation is the way to go, and, as a matter of fact, that’s what many investors have done. Since 2015, U.S.-based investors have taken their portfolios from roughly 75% U.S. stocks to over 82%.1 That is a big change and creates a positive feedback loop: investors earn higher returns in U.S. stocks, investors assume there is no alternative to U.S. stocks, investors buy more U.S. stocks, U.S. stocks go higher. Come to find out, the last point is an important one. Increased demand for U.S. stocks doesn’t make company fundamentals grow faster, it just pushes up their stock prices.
So just how much of U.S. outperformance is coming from that increase in “valuation” (the price an investor pays for each dollar of earnings)? For the past decade, it was over 40% of the total outperformance.2 For the past 30 years, it was over 70%.3 Multiple expansion has driven a huge portion of this outperformance with much of the balance coming from a strengthening U.S. dollar. U.S. earnings growth certainly has been better than the rest of the world on average, but has been a relatively small contributor to its additional return.
The Case for International
Throughout the 30-odd year period this piece is analyzing, many investors have made their case for international stocks, but the sheer momentum of the U.S. market has often made this group of staunch supporters relatively few and far between. A few of the most common reasons cited for holding international stocks are:
1. Their existence alone presents opportunity. At 40% of global market cap4, 85% of global GDP, and 90% of the world’s listed companies, leaving international stocks out of a portfolio is leaving a lot of stones unturned.
2. The U.S. has a few troubling market and economic statistics. Its market is concentrated and highly valued, its currency is expensive, and its government debt and continued deficits could be cause for concern.5
3. Diversification improves portfolio efficiency. While correlations between U.S. stocks and non-U.S. stocks have increased through this bull market run, during longer bear market shifts (when investors need diversification the most), correlations tend to break down.6 Through cycles, this is intended to improve risk-adjusted returns and keep investors in the market during periods of prolonged pain.
The WoodTrust Approach to International
WoodTrust recognizes the rationality behind all of the above points; however, points one and two tend to require something extra to successfully drive investment decisions: a catalyst. While it is perfectly reasonable to assume there are good opportunities internationally given the significant number of companies and countries out there, if there isn’t a specific action to cause them to grow faster or get investors’ attention, the stocks will never catch a bid. Similarly, while the U.S. market, economy and currency may appear “stretched”, making the timing decision of when that stretching has gone too far is endlessly complicated, if not impossible.
Diversification (point three), on the other hand, is something that is approached methodically and strategically over time. Diversification involves building conviction in a winning allocation decision that makes sense over several cycles and making small tweaks at the margin as markets move through those cycles to be sure the advantages of diversification are optimized. This is the strategy WoodTrust employs.
As Loyal readers will remember the 4Q23 WoodTrust Market Perspectives that spoke to the firm’s program construction – a significant component of which is the international allocation. By combining the long-term capital market assumptions from WoodTrust’s partners at JPMorgan with internal portfolio modeling, the firm selects the optimal weight for international stocks to minimize portfolio volatility. This process is done on a recurring basis, and its most recent iteration led to the firm increasing its program-wide international stock target weighting from 25% to 30% during the first quarter of 2025. While WoodTrust’s stock programs usually have a majority of their funds allocated to U.S. companies, the firm finds tangible benefits in a strategic allocation to stocks outside of the country’s borders.
In Summary
U.S. stocks have had quite the run, and we recognize that our U.S. overweight has helped drive significant outperformance against the global market-cap weighted portfolio. While we can appreciate everything that makes U.S. capital markets great, we are also aware of the benefits of owning an array of assets that are not perfectly correlated to improve overall portfolio efficiency. By maintaining a strategic allocation to international stocks and adjusting that allocation at the margin when relative volatility expectations necessitate it, we are able to accomplish that efficiency goal. As always, we thank you for your trust and look forward to our meetings with you in the near future.
1https://www.morningstar.com/portfolios/how-far-out-of-whack-are-fund-investors-asset-allocations-800-billion-give-or-take
2https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/making-case-international-equity-allocations.html
3https://www.aqr.com/Insights/Research/Journal-Article/International-Diversification-Still-Not-Crazy-after-All-These-Years
4Global market cap is the combined market value of all companies globally.
5To be fair, people have been pointing to most of these statistics as problems for years while others defend their extreme levels.
6https://www.aqr.com/Insights/Research/Journal-Article/International-Diversification-Still-Not-Crazy-after-All-These-Years
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