Debunking The Reasons To Go All-In On U.S. Stocks

&l;p&g;&l;img class=&q;dam-image getty size-large wp-image-1133274345&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;680&q; data-width=&q;960&q;&g; American flag blowing in the wind, Bangor, Maine

There are many reasons to invest globally, even though &l;a href=&q;;&g;many investors neglect to&l;/a&g;. An important one is the current rich valuations of U.S. stocks. The U.S. market currently trades at 20x-30x earnings depending on whether you look at recent earnings or a longer run of history. The more you pay for a stock relative to its earnings, the more expensive it is.

&l;strong&g;High Valuations&l;/strong&g;

The current U.S. valuation is&a;nbsp;pretty high compared to the past century. It&s;s more frequently been at half the current level. Also, if you think the U.S. valuation is justified by low interest rates and you inflation, then consider that the U.S. market is a lot more expensive than most international markets which appear fairly valued, or even cheap today. Many regions of the world currently trade a under 10x earnings, with&a;nbsp;&l;a href=&q;;&g;certain countries even less expensive&l;/a&g;. Now of course, critics may point out that valuations can have little short-term impact on stock prices, that may be true, but valuations can be a robust signal of returns over the next decade, so longer term investors should be wary.

&l;strong&g;Long Time Horizons&l;/strong&g;

Yes, the U.S. economy is performing relatively well. However, economic data can change quite quickly as the &l;a href=&q;;&g;yield curve may be signalling&l;/a&g;. In fact, stock prices typically discount&a;nbsp;several decades of future earnings. This year&s;s expected profits&a;nbsp;represent under 5% of current valuations on average. As such, any short-term good news (or bad news) is less relevant than it may seem in the bigger investing picture. Bear in mind that buying a stock at over 20x earnings requires you to look over a decade into the future to get your money back on typical assumptions. This means you can&s;t just rely on a couple of good years for the economy and forget about the longer term.

&l;strong&g;Diversification Of Risks&l;/strong&g;

Also, around half of sales of larger U.S. companies come from overseas, but U.S. companies are still disproportionately impacted by U.S. trade and taxation policies, so owning U.S. stocks and global stocks&a;nbsp;is not equivalent. Looking overseas can still&a;nbsp;help you diversify&a;nbsp;across a number of factors whether in politics, trade or policy. Currencies matter too, at the moment the dollar may be&a;nbsp;on the&a;nbsp;expensive side relative to major currencies, and putting your money overseas may be prove&a;nbsp;helpful should the dollar weaken.

&l;strong&g;Sector Exposure&l;/strong&g;

There are also significant sectors of the global economy, such as renewable energy, electronics manufacturing and certain natural resource sectors that are relatively under-represented within the U.S. stock market. This is because the U.S. isn&s;t engaged in&a;nbsp;all sectors of the global economy. Therefore, by investing globally you may pick up exposure to industries that simply are not accessible to U.S.-focused investors.

Of course, one reason that the U.S. market may be expensive is the higher weighting to tech within the U.S. market given that tech currently trades at a higher valuation than most other sectors. However, China has many similar tech firms, but commands a much lower valuation. Also, it remains to be seen whether U.S. tech firms can grow into their expensive valuations for the long-term.

&l;strong&g;The Dangers Of Index Weighting&l;/strong&g;

The U.S. may also benefit from its current generous&a;nbsp;valuation due to how country exposure is weighted&a;nbsp;within funds.&a;nbsp;&l;a href=&q;;&g;Many funds calculate benchmarks to invest against based on current market valuations&l;/a&g;. The U.S. market has had a good run and currently represents around 55% of global benchmarks in early 2019. The more the U.S. rises, the greater proportion of the global market it represents. If you think about it, from a valuation standpoint, that&s;s backwards. Expensive countries would carry greater index weights, all else equal. This is not what you would want as a value-oriented investor.

This means if you put a dollar into a global fund, more than half of that money will be invested in the U.S. In recent history the U.S. share of global markets has moved around and sometimes been closer to 40%. That&s;s a lot lower than current levels.

Therefore, owning a global fund and thinking you don&s;t have to worry about U.S. valuations is only half right. Remember that the share of the U.S. in those funds has crept up in recent years. You may end up with the greatest U.S. exposure right when the U.S. is most expensive.

You could consider managing your own U.S. exposure by combining owning a global fund (ex-U.S.) and a U.S. market tracker. By&a;nbsp;blending these two funds in a portfolio, you can make sure the U.S. exposure is where you want it, rather than drifting with current valuations.

&l;strong&g;Comparisons To Index Weighting&l;/strong&g;

Another way to think about the U.S. market weight of approximately 55% is to compare it with other metrics. The U.S. represents &l;a href=&q;; target=&q;_blank&q;&g;around a quarter of global GDP&l;/a&g;, which is a measure of economic activity. The U.S. also has around 5% of the global population.

Here again, we must remember that U.S. stocks do substantial business overseas, but assuming that half of U.S. profits come from outside the U.S., U.S. stock valuations may still be somewhat inflated. There&s;s quite a disconnect between the proportion of the global stock market that the U.S. represents and its weight in other economic metrics.

Clearly, for a U.S. investor, having U.S. stock exposure is a often necessary. Nonetheless, there&s;s an important question as to what that exposure should be. Many investors set their &l;a href=&q;;&g;U.S. exposure higher than theory would suggest&l;/a&g;&a;nbsp;and their are plenty of reasons to be skeptical about U.S. stock valuations on a medium-term view. Taking action now to make sure your U.S. exposure is prudent makes sense, 100% U.S. exposure may be where many investors are currently, but may well not be the appropriate level for the future.&l;/p&g;

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