Are U.S. investors addicted to domestic equities? Among major developed countries, U.S. investors’ portfolios have the largest proportion of domestic exposure. But with skyrocketing valuations, are investors treading dangerous waters?
As of December 2014, the share of home equities in U.S. investors’ portfolios was 79% – the highest among Canada, the U.K., Australia and Japan, according to 2017 research by Vanguard. In comparison, U.S. equities’ weight in market-cap for global equity index was around 51%
The home bias could be potentially getting self-reinforced by returns. As of June 30, 2017, the annualized gross returns over the past five years was +14.6% for the MSCI USA index – outperforming the MSCI World’s +12.01%. (The MSCI World captures large and mid cap representation across 23 Developed Markets; the MSCI USA measures the performance of the large and mid cap segments of the U.S. market. Each index covers approximately 85% of the free float-adjusted market capitalization in the respective markets).
US Earnings are Solid, But Beware of Home-Bias Driving Overvaluation
Corporate fundamentals in the U.S. are potentially adding to the market’s attractiveness. S&P 500 earnings in Q1 2017 grew at a record pace (+13%) from the same quarter a year ago. Furthermore, the dollar value of earnings in Q2 is expected to reach a new high (according to Zacks Earnings Trends report). The growth outlook for coming quarters looks solid as well. Does that validate U.S. investors’ home-country bias? Sure, Corporate America has strong fundamentals to back its equity, but what also cannot be ignored is that its shares are trading at record-high overall valuations.
As of August 1, the S&P 500’S Cyclically Adjusted Price-to-Earnings (CAPE) ratio is nearly 30.5 – the highest it has ever been, apart from certain months before the historic crashes of 1929 and 2000. U.S. equity has also been deemed as the priciest among 40 countries based on several valuation metrics, by StarCapital’s research, as of June 30.
That does not mean you have to shun U.S. holdings altogether. It sure makes sense to invest in equity of a U.S.-based firm if its long-term prospects look strong. But, if your love for a company is making you overlook fundamentals and/or sacrifice diversification, it is time to rethink your investing bias.
Go For ‘Fundamental’ Diversification
To be sure, many foreign assets, such as those of emerging market equities, might not suit every investor’s risk appetite. But if it’s mere “comfort of home” and/or lack of adequate knowledge about other countries’ markets that is making you shy away from diversification opportunities, your wealth management could be lacking efficiency. That’s why, at Zacks Investment Management (ZIM), we use independent market research on domestic and international fundamentals to build customized allocations for our clients, based on investors’ individual financial needs and risk tolerance.
A common investing mistake is getting carried away by momentum and piling up on overvalued stocks. This could be one of the tendencies driving a domestic-equity bias. Such a portfolio could be vulnerable to sharp losses due to potentially insufficient diversification. That’s because corrections are inherently going to follow overheated markets. Although it is hard to predict market turns, having diversified portfolios helps to cushion downside risks when they emerge. At ZIM, we use in-house databases and tools to assess various valuation metrics to help our clients build portfolios based on fundamentals versus biases.
Bottom Line for Investors
Do not let a home-country bias or any ‘emotional’ factor come in the way of fundamentally driven investment logic. Sure, our country’s corporate fundamentals are on a solid footing, but the overall record high valuation makes it crucial to reassess your portfolio.
Some amount of diversification in your portfolio could be beneficial. But, how much of it is suitable for your financial goals and risk tolerance is something you should think through before making a decision. A financial or wealth management expert can help you with this.
Seeking the right information and guidance can go a long way in helping you choose asset allocations that can take care of your financial goals and risk tolerance. At Zacks Investment Management, we use our in-house tools and unbiased research to keep our clients up-to-date on fundamentals. That way, we help them build their nest eggs with confidence. If you need help understanding whether your current plans meet your financial goals, time horizon, and risk preference, call us at 1-888-600-2783, and we’ll be happy to answer your questions and give you more details about our services. In the meantime, check out our Dean’s List. This briefing gives a sneak peek into our top-performing investment strategies. Click on the link below to download your exclusive copy today:
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