Financial Planning

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A Time-Tested Strategy Under Scrutiny

Investing in global markets offers a wealth of opportunities, but it also requires a deeper understanding of how these markets behave over time. While much of the focus tends to be on the U.S. stock market, it’s important to consider how international markets have performed as well. A question often asked is whether the impressive long-term returns of U.S. stocks are unique or if similar results can be found globally. The data provides some insightful answers, particularly when we examine the performance of the MSCI World ex-U.S. Index compared to the S&P 500 over various time horizons.

The U.S. Stock Market: A Benchmark for Success

Historically, the U.S. stock market has been a powerhouse. Since 1926, U.S. stocks have delivered positive returns:

These numbers are impressive, and they reinforce the idea that time in the market, rather than timing the market, is crucial for success. The U.S. market’s ability to generate positive returns consistently over long periods is why many investors view it as a “safe bet.” However, does this phenomenon extend to international markets?

The Global Perspective: How Do International Stocks Stack Up?

International stock data, specifically from the MSCI World ex-U.S. Index, offers valuable insights into how markets outside the U.S. have performed. While we only have data from 1970 onward, this still provides more than 50 years of market history to analyze. Here’s how the global markets compare to the U.S. in terms of positive returns over different time frames:

• Rolling Monthly Returns: The S&P 500 has outperformed.
• Rolling 12-Month Returns: Again, the S&P 500 leads.
• Rolling 5-Year Returns: The MSCI World ex-U.S. Index shows a slight edge.
• Rolling 10-Year Returns: International stocks have a higher win percentage.
• Rolling 15 and 20-Year Returns: Both markets perform similarly.

These results highlight that while the U.S. market has outperformed over shorter periods, international markets hold their own—and even surpass the U.S.—over longer time frames.

The Cyclical Nature of Global Markets

One of the key takeaways from analyzing global and U.S. stock returns is that markets are cyclical. There are periods when U.S. stocks lead the way, and other times when international markets take the spotlight. These cycles are evident when we examine rolling 5-year and 10-year returns, where the leadership alternates between U.S. and international stocks.

See this chart below and you can see that there is a cyclical nature of when the U.S. and international stocks outperform, when looking at 5-year monthly rolling returns:

The chart above shows the values of the S&P 500 Index’s returns minus the MSCI World ex USA Index’s returns. When the line is above 0, domestic stocks outperformed international stocks. When the line is below 0, international stocks outperformed domestic stocks.

US equity is represented by the S&P 500 Index; international equity is represented by the MSCI World ex USA Index. Please see below for representative index definitions. For illustrative purposes only.

For instance, there have been times when international stocks, buoyed by strong economic growth in regions like Europe and Asia, outperformed the U.S. market. However, recent history has seen U.S. stocks, driven by tech giants and a robust economy, dominate the global scene. This cyclical nature underscores the importance of diversification in an investment portfolio.

The Cyclical Case for International Exposure: Higher Expected Returns

Over the past decade, a broadly diversified U.S. stock portfolio would have returned almost twice as much as a comparable international portfolio for a U.S.-based investor. This disparity in performance may lead some investors to question their allocation to non-U.S. stocks. However, there is reason to believe that the next decade could look very different.

From April 1, 2013, through March 31, 2023, U.S. stocks outperformed their international peers by an average of 7.5 percentage points annually. This outperformance was primarily driven by rising stock valuations and higher earnings in the U.S., which contributed 3.3 and 3.2 percentage points, respectively. Valuations expanded faster in the U.S. due to higher growth expectations for the American economy and earnings. Additionally, the U.S. dollar’s strength over the past decade subtracted 2.1 percentage points from international returns, overshadowing the 1.1 percentage points of outperformance from higher dividend yields in international markets.

Looking ahead, the situation may reverse. Projections suggest that international stocks could outperform U.S. stocks by an average of 2.2 percentage points annually from March 2023 through March 2033. This expectation is based on median projections of 5.1% annual returns for U.S. stocks and 7.3% for international stocks. This potential shift underscores the cyclical nature of markets and the importance of maintaining a diversified portfolio.

Surprising Facts About International Markets

One of the most surprising findings is that international stocks actually have a higher winning percentage than U.S. stocks over 5-year and 10-year periods. This runs counter to the common perception that the U.S. market is always the best performer. The magnitude of returns, however, often overshadows these winning percentages. While the U.S. market has indeed delivered substantial gains, the consistent positive performance of international markets is a reminder that long-term investing works globally, not just in the United States.

The Importance of Patience and Diversification

Whether you’re investing in the U.S. or international markets, patience remains the ultimate equalizer. The data shows that the longer you stay invested, the higher your chances of achieving positive returns. This principle applies globally, reinforcing the value of a diversified portfolio that spans different geographies. By investing across various markets, you mitigate the risk associated with any single country’s economic downturn, while still capturing growth opportunities worldwide.

“The stock market is a device to transfer money from the ‘impatient’ to the ‘patient’.” ~Warren Buffett

Long-Term Investing Knows No Borders

The data speaks for itself: long-term investing is not a U.S.-only phenomenon. While the U.S. stock market has a storied history of success, international markets offer compelling opportunities as well. With a commitment to patience and diversification, investors can achieve positive returns whether they focus on domestic or global markets. In a world that’s increasingly interconnected, looking beyond borders is not just advisable—it’s essential for a well-rounded investment strategy.

To take the next step in understanding your portfolio’s performance and determining your risk number, we invite you to reach out for a complimentary call or coffee. We are here to assess your current portfolio and guide you through aligning it with your long-term goals. Start by visiting investedwithyou.com and clicking on the “Get Started” button. We look forward to helping you achieve greater financial confidence.

References:

https://awealthofcommonsense.com/2023/05/the-stock-market-is-not-a-casino/

https://www.hartfordfunds.com/practice-management/client-conversations/investing-for-growth/us-and-international-markets-have-moved-in-cycles.html 

Disclosure: The information provided in this article is for educational and informational purposes only. The returns mentioned, such as the historical performance of the MSCI USA and other market indices, are based on past data and do not guarantee or predict future performance. Investing involves risks, including the potential loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. All investments should be made based on your own goals, risk tolerance, and time horizon. Please consult with a financial advisor, such as Intelligent Investing to determine the strategy that best suits your individual situation.

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A Time-Tested Strategy Under Scrutiny

The 60/40 portfolio, composed of 60% U.S. stocks (often represented by the S&P 500) and 40% U.S. fixed income (commonly represented by the Barclays U.S. Aggregate Bond Index or 5-year/10-year Treasuries), has long been a cornerstone of traditional investment strategy. This allocation has provided a balanced approach to growth and stability, blending the potential returns of equities with the steady income and lower volatility of bonds. However, recent market dynamics, especially the turbulent year of 2022, have put this strategy under pressure and raised questions about its continued viability.

Despite these challenges, a deeper analysis of historical data reveals that the 60/40 portfolio remains a robust option for long-term investors or intelligent investors. As we examine the historical performance of this allocation, it becomes clear that the win rate—defined as the probability of achieving positive returns—improves significantly over time.

First a look at just equities- The S&P 500

As you can see from above, if you held the S&P 500 for at least 12 years, you would have a 100% win rate. But most portfolios don’t consist only of the S&P 500, so let’s dig a bit deeper and add another asset class—fixed income.

The Historical Performance of the 60/40 Portfolio

One of the key strengths of the 60/40 portfolio lies in its ability to deliver consistent returns over various time horizons. By analyzing data dating back to 1926, we can observe the resilience of this allocation across different market environments. In the examples below, the 40% allocation of fixed income is using 5 year US Treasuries as a proxy.

Monthly Returns: On a month-to-month basis, the 60/40 portfolio exhibits similar win rates to the stock market (S&P 500), albeit with slightly lower volatility. This is due to the stabilizing influence of bonds, which tend to perform well during periods of economic uncertainty.

1-Year Returns: Over a one-year period, the win rates for the 60/40 portfolio slightly outperform those of a pure equity portfolio. The inclusion of fixed income provides a cushion against market downturns, resulting in more consistent positive returns.

3-Year and 5-Year Returns: As the investment horizon extends to three and five years, the win rates for the 60/40 portfolio continue to improve. The diversification benefits of holding both stocks and bonds become more apparent, reducing the likelihood of experiencing negative returns.

10-Year Returns: Perhaps most impressively, the 60/40 portfolio has never delivered a negative 10-year return in its nearly 100-year history. This track record underscores the power of diversification and long-term investing. Even during periods of significant market stress, the combination of equities and fixed income has provided a reliable path to wealth preservation and growth.

Inflation-Adjusted Returns: A Closer Look at Real Returns

While the nominal (not factoring inflation) returns of the 60/40 portfolio are impressive, it’s essential to consider the impact of inflation on purchasing power. When we adjust the historical data for inflation, the win rates do decrease slightly, but the overall trend remains positive. Even in inflation-adjusted terms, the 60/40 portfolio has delivered strong long-term returns, reinforcing its status as a dependable strategy for preserving wealth.

The Importance of Time Horizon: The data is clear—the longer your investment horizon, the higher your chances of success with a 60/40 portfolio. While short-term fluctuations are inevitable, patient investors who stay the course are rewarded with positive outcomes more often than not.

Preparing for Market Volatility

We’ve spent considerable time preparing our clients and their portfolios for periods of market volatility. By stress-testing portfolios, we provide clients with a glimpse of what their investments might look like during turbulent times. The key question now is whether to react in fear or to stick to the sound decisions that have been made.

Over the long term, equities serve as a hedge against inflation. A company’s earnings and revenues typically rise with inflation, contributing to higher stock prices. Since 1970, the MSCI USA has averaged an annualized return of 7.6%, outpacing the annualized inflation rate of around 4%. This is a testament to the power of long-term investing.

The 60/40 Portfolio as a Starting Point in Portfolio Construction

While the 60/40 portfolio has a long history of success, it is just a starting point in portfolio construction. The financial markets have evolved, and so have the strategies for building robust and diversified portfolios. There are strong arguments for enhancing the 60/40 allocation by adding other elements, such as:

• Global Diversification: Expanding the equity and bond allocation to include international and emerging markets can capture growth opportunities across the globe and provide additional risk diversification.
• Alternatives: Incorporating non-traditional assets such as managed futures, convertible bonds, and arbitrage strategies can add further diversification and reduce correlation with traditional stock and bond markets.

Private Equity and Infrastructure Funds: These investments offer access to opportunities that are often unavailable in public markets, potentially enhancing returns and providing an additional layer of diversification.

The Foundation of a Sound Investment Strategy

Before diving into portfolio construction, it’s crucial to understand your goals. Whether your objective is wealth accumulation, capital preservation, income generation, or a combination of these, your goals should guide your investment strategy. Once your goals are clear, the next step is to translate them into a well-thought-out plan. This plan then serves as the blueprint for building a diversified portfolio tailored to your unique needs.

However, even the most carefully crafted portfolio can be derailed by emotional decision-making. Headlines, market noise, and short-term volatility often tempt investors to make impulsive changes that can jeopardize long-term success. This is where Intelligent Investing comes in. We guide our clients in navigating the path to financial independence by consistently doing the right thing and avoiding the ledges of fear and greed.

Helping You Stay the Course

At Intelligent Investing, we believe that staying disciplined is key to achieving long-term success. Our approach is to help clients remain focused on their goals, avoid knee-jerk reactions to market events, and make informed decisions based on data and sound principles. By partnering with us, you gain access to expert guidance, a customized investment strategy, and the peace of mind that comes from knowing your portfolio is aligned with your goals.

We’d love to offer you a complimentary coffee or call to learn more about your financial situation and help you develop a written plan for you and your family. Visit investedwithyou.com and click on the “Get Started” button to begin your journey to becoming the next intelligent investor.

Disclosure: The information provided in this article is for educational and informational purposes only. The returns mentioned, such as the historical performance of the MSCI USA and other market indices, are based on past data and do not guarantee or predict future performance. Investing involves risks, including the potential loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. All investments should be made based on your own goals, risk tolerance, and time horizon. Please consult with a financial advisor, such as Intelligent Investing to determine the strategy that best suits your individual situation.

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Staying the Course During Market Corrections

C.S. Lewis once wrote, “When the whole world is running towards a cliff, he who is running in the opposite direction appears to have lost his mind.” This sentiment is particularly relevant in today’s financial climate, where headlines are dominated by fears of a market correction following a weak jobs report and a subsequent Nasdaq downturn. As recession concerns grow, it’s crucial to recognize that what seems like chaos in the short term is often just part of the market’s natural cycle.

Our Philosophy: Driven by Goals, Not Headlines

This recent market correction aligns with our earlier analysis, where we observed a speculative rush into the tech sector, fueled by fear of missing out on the artificial intelligence boom. Now, the market is reverting to the mean—a typical and necessary process in maintaining long-term stability.

At Intelligent Investing, we emphasize an investment philosophy that is designed to withstand market cycles with patience and discipline. Our clients’ financial goals, rather than fleeting news headlines, guide our decision-making process. We regularly review our clients’ specific risk profiles and make necessary adjustments to their portfolios, ensuring they remain aligned with their long-term objectives.

While we stay informed about market developments, we avoid overreacting to the alarmist headlines often seen on Wall Street. History has repeatedly shown that markets recover from downturns—whether it was the selloff in 2018, the COVID-19 crash, or the correction in 2022. Each time, the market rebounded to new highs.

Fear and Greed: A Dangerous Duo

Currently, the CNN Fear and Greed Index hovers around 19, indicating extreme fear in the market. We’ve seen it dip even lower in the past when short-term investors, driven by emotion, made impulsive decisions. As Warren Buffett wisely advised, “Be fearful when others are greedy and greedy when others are fearful.” This principle is central to our investment strategy.

It’s essential to understand that our clients’ portfolios are not limited to a single asset class like the S&P 500. Instead, they are diversified across multiple asset classes, including international investments, which helps spread risk. These asset classes are not 100% correlated, meaning when one zigs, another may zag. This diversification can mitigate risk, though it doesn’t eliminate it completely.

Utilizing Our Risk Software

Our proprietary risk software is a critical tool that helps us calculate a 95% historical range for portfolio performance. For example, a portfolio with a risk number of 45 might typically experience fluctuations between -8% and +12% over six months. These movements are within the normal range for such a portfolio.

However, markets can sometimes swing into 5% probability events, where downturns exceed the 95% historical range. While we can’t predict these periods with certainty, we’ve seen similar scenarios during the 2008/2009 financial crisis and the initial COVID-19 shock in 2020.

At Intelligent Investing, we regularly review our clients’ portfolios to determine if rebalancing is necessary. This doesn’t involve market timing, which is notoriously ineffective. Instead, we rebalance when we identify opportunities to realign portfolios with the risk parameters established during calmer times, all while considering the tax implications.

A diversified portfolio that includes both equities and fixed income tends to self-rebalance over time. When panic leads investors to sell equities in favor of safer assets, the value of fixed income typically increases as yields fall. Conversely, when the panic subsides, equities often recover and even reach new highs.

Preparing for Market Volatility

We’ve spent considerable time preparing our clients and their portfolios for periods of market volatility. By stress-testing portfolios, we provide clients with a glimpse of what their investments might look like during turbulent times. The key question now is whether to react in fear or to stick to the sound decisions that have been made.

Over the long term, equities serve as a hedge against inflation. A company’s earnings and revenues typically rise with inflation, contributing to higher stock prices. Since 1970, the MSCI USA has averaged an annualized return of 7.6%, outpacing the annualized inflation rate of around 4%. This is a testament to the power of long-term investing.

Understanding Market Corrections

A market correction is a decline in the value of a stock market index or asset, typically ranging from 10–20% from a recent peak. Such corrections are a normal part of market behavior, occurring nearly every year. Historically, equity markets experience a 15% decline on average each year, with deeper declines happening roughly once every five years.

It’s essential to understand that no one, no matter how informed, can predict the depth of this or any other correction. For long-term, goal-focused investors, these short-term fluctuations should be of little concern.

For those still in the accumulation phase, market declines present an opportunity to purchase shares at discounted prices. What the media portrays as a “correction” is often a “sale” for those accumulating assets. Conversely, for those drawing on their investments in retirement, it’s crucial to remember that portfolios are designed to serve financial plans, which are rooted in personal goals—not in reaction to current events.

As we navigate this correction, it’s important to remember the four scariest words in investing: “This time is different.” An intelligent investor knows that staying the course and focusing on long-term goals is the key to success during turbulent times.

If you or someone you know is feeling anxious about the current market, we would be happy to provide peace of mind and help reduce financial stress. Feel free to reach out to us at Intelligent Investing for a complimentary conversation about how we can assist in managing your financial future. Simply visit investedwithyou.com and click on the “Get Started” button.

Disclosure: The information provided in this article is for educational and informational purposes only. The returns mentioned, such as the historical performance of the MSCI USA and other market indices, are based on past data and do not guarantee or predict future performance. Investing involves risks, including the potential loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. All investments should be made based on your own goals, risk tolerance, and time horizon. Please consult with a financial advisor, such as Intelligent Investing to determine the strategy that best suits your individual situation.