Most investors know they’re supposed to diversify internationally. At the moment, though, that seems like a notion only a daredevil could love.
Where are you supposed to put your loonies? In a U.S. market that appears, in some eyes, to be verging on a recession? In Europe, where Brexit is likely to keep nerves on edge for months to come? Or in Asia, where China’s attempted clampdown on Hong Kong could spiral into something far uglier?
The tariff war between the U.S. and China, a slowing German economy and worries about China’s mountain of debt add to the potential risks of international investing. Small wonder, then, that many Canadian investors stick close to home, clutching a handful of familiar names in their portfolios.
This stay-at-home approach seems logical. It isn’t, though. For all the apparent risks involved with international investing, it tends to pay off over time. Over the past few years, people who have refused to venture outside Canada’s borders have cost themselves significant money.
Since September, 2014, the S&P/TSX Composite Index has been one of the worst places in the world to invest. It has produced a total return (that is, with dividends included) of 4.2 per cent a year, lagging behind the U.S., Europe, Asia and emerging markets.
The domestic picture looks particularly nasty when compared with the S&P 500 index in the United States. The American benchmark has generated total returns of 14.5 per cent a year (in Canadian dollars) during this span, more than three times what you would have achieved in Canada.
poor performer
Canada’s stock market has been one of the worst
places to invest over the past five years.
Exchange
Returns (9/5/2014 – 9/5/2019)
U.S.: S&P 500 (SPX)
14.53%
Asian stocks (MXAP)
7.77%
European stocks (MXEU)
5.94%
Emerging markets (MXEF)
4.74%
Canada: S&P/TSX
Composite (SPTSX)
4.17%
john sopinski/the globe and mail
source: bloomberg
poor performer
Canada’s stock market has been one of the worst
places to invest over the past five years.
Exchange
Returns (Sept. 5, 2014 – Sept. 5, 2019)
U.S.: S&P 500 (SPX)
14.53%
Asian stocks (MXAP)
7.77%
European stocks (MXEU)
5.94%
Emerging markets (MXEF)
4.74%
Canada: S&P/TSX
Composite (SPTSX)
4.17%
john sopinski/the globe and mail, source: bloomberg
poor performer
Canada’s stock market has been one of the worst places to invest over the past five years.
Exchange
Returns (Sept. 5, 2014 to Sept. 5, 2019)
U.S.: S&P 500 (SPX)
14.53%
Asian stocks (MXAP)
7.77%
European stocks (MXEU)
5.94%
Emerging markets (MXEF)
4.74%
Canada: S&P/TSX
Composite (SPTSX)
4.17%
john sopinski/the globe and mail, source: bloomberg
Optimists will argue the recent patch of weakness reflects the one-time shock of falling oil prices on Canada’s energy companies and is just a passing phase. Unfortunately, though, the results don’t look much better if you extend your horizon back in time. Over the past 10 years, Canadian stocks lagged their U.S., European and Asian counterparts, beating out only emerging markets. Over 15 years, we finish in the middle of the pack, finishing behind both the U.S. and emerging markets and only marginally ahead of Asian markets.
The biggest reason for Canada’s lacklustre showing is structural. Canadian stocks account for only about 3 per cent of the global total and aren’t exactly a widely diversified bunch. Banks, oil producers and miners dominate the Toronto exchange, while technology, consumer brands and health care get scant attention.
Over time, the lack of sectoral diversification means the Canadian market will be vulnerable to long periods of lagging performance. Whenever banks, oil producers or miners are out of favour, Canadian investors are likely to struggle.
The implication is clear: Canadians should have at least some international exposure. But where? This is where things get tricky.
One notion is simply to branch into U.S. stocks, perhaps by buying a low-priced S&P 500 index fund. The U.S. benchmark exposes investors to a much wider selection of industries than its Canadian equivalent. It includes technology giants and defence contractors, as well as a wide assortment of leading consumer brands, drug makers and manufacturers.
Better yet, the U.S. market has been on a tear. Since its lows in the financial crisis, it has quadrupled investors’ money, leaving every other stock market in the world in its dust.
This all sounds tempting. But there are issues. For starters, recession risks are rising according to indicators such as the bond market’s yield curve. On top of that, U.S. stocks appear fully valued. The cyclically adjusted price-to-earnings ratio (CAPE), a measure of how stock prices compare with corporate profits over the past decade, says U.S. stocks are now more highly valued than at any time outside the dot-com bubble and the run up to the Great Depression.
If you want to start a fight among finance types, ask them whether U.S. stocks are expensive. Some, like Lawrence Hamtil, an influential financial blogger and adviser at Fortune Financial in Kansas City, acknowledge that other countries’ stock markets look cheaper than the U.S. on measures such as share prices to earnings or CAPE, but argue this is only because other markets tilt more heavily toward cheaper, less attractive sectors, such as banks, automakers and miners. Adjust for differences in sector composition, and much of the apparent valuation gap between the U.S. and other markets disappears, Mr. Hamtil says.
Others disagree. Rob Arnott, founder of Research Affiliates LLC, a widely followed market analysis company in Newport Beach, Calif., says the U.S. market is primed to produce dismal returns over the next decade because it is so highly valued now. He says he has no exposure to U.S. stocks at these prices. Instead, he has half his net worth in emerging markets deep-value stocks, with smaller exposures to Europe and Japan.
The simplest solution may not be to pick individual markets but to diversify widely. Bridgewater Associates LP, the U.S. hedge fund manager, argues for this approach in a report earlier this year. Bridgewater researchers Melissa Saphier, Karen Karniol-Tambour and Pat Margolis show that the performance of individual national stock markets has fluctuated wildly in each decade since 1900. Canada, for instance, was a miserable performer during the 1980s, an average performer in the 1990s, a leading performer in the first decade of this century, and a lagging performer since.
The Bridgewater team argues the best approach is for investors to spread their bets among a wide number of national markets. “A geographically diversified portfolio creates a more consistent return stream that tends to do almost as well as whatever the best single country turns out to be at any point in time,” according to the researchers.
Building a geographically diversified portfolio is easier than you think. Both Vanguard Canada and BlackRock Inc.'s iShares offer all-in-one exchange-traded funds (ETFs) that combine an international range of stocks with a hefty helping of bonds. Both the iShares Core Balanced ETF Portfolio (XBAL) and the Vanguard Balanced ETF Portfolio (VBAL) are cheap, with management expense ratios of 0.25 per cent or less. They are sensible ways for Canadian investors to diversify globally.
Ian McGugan