If you read magazines, watch the news or even just log on to social media, you may see a common theme: the world is more interconnected than ever before.
However, this isn’t a new phenomenon. As every decade in modern history passes, the world continuously grows closer—economically speaking. Unfortunately, many investors are just beginning to understand the effects. And even though they acknowledge it, some still ignore investments outside of their home countries. This means many investors are missing out on some of the best investing opportunities in the world.
One reason some investors fail to invest globally is they perceive foreign stocks are riskier than domestic stocks. There’s an inherent fear of the “unknown.” But the real risk is missing out on global investing opportunities and being too concentrated in just one country. For most investors, the logic of diversification is intuitive. Spreading your risk across various countries can help protect yourself from crises, trends, or other events that disproportionately impact a single country’s market.
Capital Markets—Global for Centuries
The connection between global economies may seem intuitive today, but it wasn’t just a few decades ago: What happens in one country has measurable effects on another. This extends to capital markets, too. While market returns may differ, market direction rarely does. And if markets do move differently, they often snap back fast.
Just as finance theory suggests, well-constructed indexes should arrive at a similar place over the long term. As far back as reliable market data goes, non-US developed markets have annualised 9.1% and US stocks 10.2%.[i] Figure 1 shows just how closely related global indexes are over nearly 50 years of history. The S&P 500 and the MSCI EAFE are stock indexes that represent the US and non-US developed markets respectively.
Figure 1 S&P 500 and MSCI EAFE Annual Returns—Strongly Correlated
Sources: Global Financial Data, S&P 500 total return, MSCI EAFE net return, from 31/12/1969 to 31/12/2018.
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