It Is Unwise to Allocate Even 50% of Equity Exposure to US Stocks

[CM]

If you are a boglehead/indexer/EMH-believer (like WCI, PoF, and most forum participants), then you should allocate less than 50% to US stocks because the US holds less than 50% of the global market cap.

If you are a value investor (like me), then you should hold much less than 50% in US stocks because:

"Using Shiller’s cyclically adjusted P/E (CAPE) ratio, one of many valuation measures, Exhibit 3 illustrates both the expensiveness of US stocks and the relative attractiveness of developed and emerging equities. A yawning gap has opened up in the relative multiples for these various geographic exposures. Today’s CAPE of 29x for US equities does not look too stretched in this exhibit. The second chart below, however, puts the expensiveness of the US markets into broader perspective. The market is trading in the most expensive ventile in history! The only other times US equities have been this expensive on this measure include 1929, the peak of the Internet bubble, and in 2008, just before the GFC. For those inclined to dismiss CAPE, other valuation metrics such as the Price/Sales ratio have soared to dizzying heights as well."

This excerpt (above) is from a GMO-authored article on Morningstar: http://news.morningstar.com/articlenet/SubmissionsArticle.aspx?submissionid=224474.xml.

The US has now out-performed for a long stretch, but this is unlikely to be a permanent condition. (See handy graph of historical relative performance in the article above.)

 

 

[The White Coat Investor]

My crystal ball always seems so much murkier than that of the financial press, but in retrospect my plan usually works better in the long run than the one suggested in the article of the day.

If the issue is recent excellent returns, international is thumping domestic so far YTD. Whether that continues in the near or long term future, I have no idea.

[CM]

The White Coat Investor wrote:

Whether that continues in the near or long term future, I have no idea.

Click to expand...

"My crystal ball always seems so much murkier..."

If your equity allocation differs from the market (e.g., US greater than 50%), then you are investing as if you know better than the market, i.e., your crystal ball is clearer.

[Zaphod]

CM wrote:

The White Coat Investor wrote:

Whether that continues in the near or long term future, I have no idea. 

Click to expand…

“My crystal ball always seems so much murkier…”

If your equity allocation differs from the market (e.g., US greater than 50%), then you are investing as if you know better than the market, i.e., your crystal ball is clearer.

Click to expand...

I think Cullen Roche has talked about this several times. He has some sort of intended (he very clearly discusses difficulty of full replication) global index fund. He has shown that interestingly its allocation is broadly tied to the economic cycle of the times and has been poorly positioned during changes. That is, heavy equities before a fall, and like now heavy bonds when they provide not much at all and may be the wrong spot. Interesting stuff nonetheless.

 

[Kamban]

I have two issues with the so called international stocks

 

1. Firstly, which international stocks. Country specific. Region specific. Continent specific. All countries and continents except USA?. I have had poor experience with the Latin America funds which once were touted as the next big thing. If total international is the way to go, you will get the dogs along with the diamonds.

3. Many large US stocks are actually international stocks, whether they be Apple, Intel, P & G, Facebook or Ford. Many get more of their revenue and profits from outside USA than from USA. And the accounting is more transparent with these companies that ones from China and Vietnam or Brazil or India.

I only own US large Cap, mid cap and small cap Vanguard funds in addition to US individual stocks. And also that dog called Janus Latin America. I am OK to be the contrarian to the crowd.

[CM]

Kamban wrote:

I have two issues with the so called international stocks

 

1. Firstly, which international stocks. Country specific. Region specific. Continent specific. All countries and continents except USA?. I have had poor experience with the Latin America funds which once were touted as the next big thing. If total international is the way to go, you will get the dogs along with the diamonds.

3. Many large US stocks are actually international stocks, whether they be Apple, Intel, P & G, Facebook or Ford. Many get more of their revenue and profits from outside USA than from USA. And the accounting is more transparent with these companies that ones from China and Vietnam or Brazil or India.

I only own US large Cap, mid cap and small cap Vanguard funds in addition to US individual stocks. And also that dog called Janus Latin America. I am OK to be the contrarian to the crowd.

Click to expand...

You aren't contrarian if you live in US and overweight US. That's what most do; overweight their home country (here and elsewhere).

Please note that I don't advocate asset allocation based on market weight. Instead, I think it's sensible to allocate based on valuation. That's why my equity allocation is almost 100% foreign now.

However, it's inconsistent to claim that you don't have better insight than the collective wisdom of the market (thus can't beat the market and shouldn't try), but then ignore the wisdom of the market by investing a greater-than-market-weight in your home country.

[hightower]

90% of my equities are US.  I hold 10% international total stock market.  I do also hold 5% international bonds.  I was considering phasing those out completely and just sticking with 20% US bonds, but I kind of like the extra diversity.  That's what I'm sticking with.  In 30 years I'll report back and let you know if it was a bad choice.  Why did I pick this?  It seemed reasonable.  But I back tested it and if I had picked this portfolio 30 years ago, I would have done just fine.  I fully understand that this same portfolio may not perform as well in the future.  But, I also understand that it could perform even better.  I have no idea how to predict what the market is going to do between now and 2047 when I'm 65 years old (hopefully).

But, I truly believe that no one knows what the future holds when it comes to picking an investment line up.  No matter how calculated of an approach you choose, there are infinitely too many variables to keep track of and I don't believe anyone can reliably predict which portfolio will perform best.  If you feel comfortable investing in 100% foreign stock, then go for it.  You might make a killing.  You might also go broke.  Who knows?   Again, in 30 years we can compare results.  But, I must admit I completely ignore all investing articles like you posted above.  Maybe actively managing your portfolio based on valuation as you do will be a winning formula.  Good for you if it is.  I'm not going to try to do that though.  Seems risky for someone like me that has no idea what I'm doing to go around reading articles like this and changing my long term plan.

I like the Boglehead approach of picking a portfolio and sticking with it for the long haul.  If the market crashes this year, oh well.  I could care less.  I'm not living on that money now.  I'll still have my shares of VTI and BND and others.  They'll just be worth a lot less.  Who cares what their value is now?  I'm 35 years old.  I'll keep buying more shares at a big discount and keep my fingers crossed that the economy recovers again.  Hopefully when I'm ready to retire I'll have enough to make ends meet.  If not, I'll adapt.

[triad]

CM wrote:

The White Coat Investor wrote:

Whether that continues in the near or long term future, I have no idea. 

Click to expand…

“My crystal ball always seems so much murkier…”

If your equity allocation differs from the market (e.g., US greater than 50%), then you are investing as if you know better than the market, i.e., your crystal ball is clearer.

Click to expand...

I agree with this point.  Seems intuitive to allocate by market cap.   I don't do that because so many people who are much smarter then I am advocate to be US heavy though I might reconsider my AA in the future.

[CM]

hightower wrote:

I have no idea how to predict what the market is going to do between now and 2047 when I’m 65 years old

Click to expand...

A lay person would have a similar reaction if you asked him to diagnose his grandmother's illness. "There is no way to know."

If he knew grandma had drenching night sweats, a high fever, horrible malaise, weight loss, jaw claudication, and temporal headaches, that wouldn't help much. Even if he knew her sedimentation rate was 110 (what's a sed rate?) when she suddenly lost vision, he'd remain clueless.

However, if grandson was a rheumatologist, he'd be fairly confident that she had Giant Cell Arteritis. He might be wrong, but that diagnosis would be at the top of the list. The grandson would know this because he has the necessary education.

 

The market is not an inscrutable magic box. Though no one can provide a precise number, one can make an educated projection with reasonable 95% confidence intervals. Returns can be broken down into their components (starting yield, growth, and valuation), and none of them can go to infinity. Starting yield is a given. Reasonable people can disagree about future growth and valuation, but there are limits to what is reasonable.

It isn't reasonable to think that grandma's problem is appendicitis, and it isn't reasonable to project 10% long-term real growth in earnings or dividends.

 

[Complete_newbie]

Im with CM in the overall sense.

I just have never been very comfortable with "the market". No matter how I slice and dice it, the message of indexing/Boglehead is stay the course and passively invest. While its easy, it just isn't investing. I mean if market drops (and it will) we are relying on it to come back to make us whole. All of this is riddled with assumptions. Its all hoping/probably sort of thing. I am certainly not evaluating cash flow, balance sheet, demand, growth of any company for next 5 years here.

I don't know. I am doing it, but this is not going to be my retirement bet. Its a side benefit from work (401 K). My taxable will go to RE or businesses.

[hightower]

Its an interesting debate. I do think it's true that passive investing relies on active investing to work. I wonder if all we are seeing is differences in personality? Active investing seems more ego driven to me. It's dominated by the drive to beat the market. To do better than everyone else. Passive investing is more scavenger driven. Just sit back and wait for the predators to do their thing, then swoop in and reap the rewards. After a big kill (a bull run) the returns can be great, but other times (bear markets) there's no kill at all and we all go hungry?

[ENT Doc]

CM wrote:

Kamban wrote:

I have two issues with the so called international stocks

 

1. Firstly, which international stocks. Country specific. Region specific. Continent specific. All countries and continents except USA?. I have had poor experience with the Latin America funds which once were touted as the next big thing. If total international is the way to go, you will get the dogs along with the diamonds.

3. Many large US stocks are actually international stocks, whether they be Apple, Intel, P & G, Facebook or Ford. Many get more of their revenue and profits from outside USA than from USA. And the accounting is more transparent with these companies that ones from China and Vietnam or Brazil or India.

I only own US large Cap, mid cap and small cap Vanguard funds in addition to US individual stocks. And also that dog called Janus Latin America. I am OK to be the contrarian to the crowd.

Click to expand…

You aren’t contrarian if you live in US and overweight US. That’s what most do; overweight their home country (here and elsewhere).

Please note that I don’t advocate asset allocation based on market weight. Instead, I think it’s sensible to allocate based on valuation. That’s why my equity allocation is almost 100% foreign now.

However, it’s inconsistent to claim that you don’t have better insight than the collective wisdom of the market (thus can’t beat the market and shouldn’t try), but then ignore the wisdom of the market by investing a greater-than-market-weight in your home country.

Click to expand...

I'm not sure what your strategy is here.  What did you hold in, say, 2010-2015?  Need to understand where you came from and then why you would go full bore international.  Did you sell US?  At what cap gains tax?  Keep in mind the reason the Schiller index looks bad is because it is anticipatory of a corporate tax rate reduction.  If that reduction occurs then after a few quarters that index won't look so gloomy.  And then what do you do?  Sell international and buy US, inducing cap gains taxes? What is your rebalancing strategy?  Sell the high value and go with the low value 100%?

[TheGipper]

I think over a 30-40 year accumulation time period it will make little difference whether one is 100% US equity or 100% international equity. The importance is just sticking to whatever you are using.

For example, these same arguments to overweight international could have been made four years ago, and as we all know, US has continued to dominate until this year. As with active management it's all about knowing when to get in and when to get out, which is almost unknowable. That is why CAPE valuation timing methods make sense in theory, but fail to perform better when put to actual practice.

Now in retirement/withdrawal phase I think there is a much stronger argument to be made for going with a true world market weighting and balancing US and international equities. Many have convincingly shown that reducing volatility will increase SWR during drawdown.

Personally, I'm planning on sticking with 30% international no matter what the valuations are until retirement and will consider upping to 50% when retired.

[CM]

hightower wrote:

Its an interesting debate. I do think it’s true that passive investing relies on active investing to work. I wonder if all we are seeing is differences in personality? Active investing seems more ego driven to me. It’s dominated by the drive to beat the market. To do better than everyone else. Passive investing is more scavenger driven. Just sit back and wait for the predators to do their thing, then swoop in and reap the rewards. After a big kill (a bull run) the returns can be great, but other times (bear markets) there’s no kill at all and we all go hungry?

Click to expand...

You are an active investor. The US is apparently about 37% of the global market cap (https://seekingalpha.com/article/4058359-u-s-quickly-losing-share-world-market-cap), but you have 90% of your money in US stocks.

[StarTrekDoc]

Market performance prediction cannot be related to medical symptoms and diagnostics.   Of all the predictors/tables out there, the expert managers 'doctors' don't beat the index markets over time.  That's the BH premise.

Now timing the market simply doesn't work well, but it cycles and the time wave curve is upwards.  You maybe riding it down while getting in, but does eventually go up over time -- debatable on the when, but again even the experts can't predict timing well.   So again the premise of BH is the long ride -- use time to your advantage as possible.  Get in early, often, and stay long and broad.

Unless you have a spec'd out Delorean and certain historical prices, exposure and places/timing isn't going to help much.