If you’re a U.S. investor, there are at least two biases that feature prominently in your portfolio:
1) Home bias: the tendency for individuals and institutions in most countries to hold only modest amounts of foreign equity.
2) Recency bias: the tendency to think that trends and patterns we observe in the recent past well continue in the future.
While these biases can exist in any time period, they are probably more pronounced today than most other periods in history. Why?
Because U.S. equities have, to put it mildly, been trouncing their global peers.
Over the past five years (through January 2016), the S&P 500 advanced 105% (15.4% annualized) versus a gain of only 27% (4.9% annualized) for the MSCI World (ex-US).
Remarkably, this differential in performance, while at the higher end of the historical range, is not unprecedented. We saw similar to greater outperformance from U.S. equities in the mid-1980s and mid-to-late 1990s. [Note: both periods were followed by international outperformance.]
The temptation after such periods is to abandon all foreign equity exposure and only hold U.S. stocks. After all, “diversification” outside of the U.S. has only hurt you over the past 5+ years. And indeed, if you listen to most pundits in early 2016, they will tell you this trend is likely to continue with statements like “the U.S. economy is faring much better than the global economy” and the “U.S. is the best house in a bad neighborhood.”
The problem, of course, is such analysis is backward looking. Pundits are the worst offenders when it comes to recency bias, reporting the past as if it were an effective investment strategy.
More discerning investors will ignore these pundits and note that there have been wide swings in performance between the U.S. and international stocks. Sometimes the U.S. leads and other times international stocks lead. Since 1970, the S&P 500 has outperformed the MSCI World (ex-US) in 54% of calendar years. While this is little better than a coin flip, what’s fresh in the minds of investors is the negative returns from international equities in 2014 and 2015 while U.S. stocks closed higher.
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