4th Quarter Commentary: A Happy Year for US Stocks. Internationals and Globally Diversified Portfolios? Not So Much.


The US stock market had a good – but not great year – in 2014. Despite having hit a new record high on 53 occasions during the year, the Dow Jones Industrial Average finished up only 10% for the year – not bad, but not a noteworthy year in any respect other than its having eked out 53 new highs during the process. However, despite the decent returns from US large companies, most other equity categories did not fare as well.

Here’s a short table showing the 2014 market results around the world [1]:

The first thing to notice is that only three categories had substantial returns to speak of: US Large Company stocks at 10% and then US Real Estate and US Long Term Treasuries[2], both at about 27% for the year. Over the last quarter or so, a question I have heard more than once from clients has been something along the lines of, “If the Dow is setting records every week, why isn’t my portfolio?”

There are a few parts to the answer:

  1. While the Dow did do well this year, it didn’t do THAT well. So, despite the news headlines proclaiming yet a new record high for the Dow seemingly every week, most of the records were just small and incremental bumps from the previous week’s record, and the total return for the year was only 10%. (That doesn’t really answer the question, but it’s worth noting.)
  2. The real answer is that while the Dow had a good year, international stocks in general and European stocks in particular, had a bad year – not a horrible year, mind you, but a bad enough year to offset many of the gains we were seeing from the Dow. For most of our clients, US large cap stocks account for approximately 40% to 50% of their equity portfolio[3] (which means that if you are all in stocks – and few are – 40% to 50% of your portfolio would usually be in large US companies). The remaining portion of an equity portfolio is invested in US small companies (14%), US real estate (5%), and international companies (40% to 50%). Since the international component is typically 40% to 50% of most clients’ stock holdings, that relatively large piece was enough to diminish the overall portfolio returns for many clients.
  3. In addition to the general underperformance of internationals, there was another factor that made a poor situation worse: the rise of the US dollar against other currencies, including the pound and the euro. This had the effect of making the poor foreign stock returns look even worse in US dollar terms, just as the fall of the US dollar against other foreign currencies in the early-to-mid 2000s made international stock returns that much better.
  4. And, finally, to compound the issue a bit, most bond categories did not provide much help this year, with record low interest rates continuing to keep short-and-intermediate term high quality bond returns between 0.5% and 3%. As noted previously, long term bonds were the exception, but see the footnote on the preceding page for a short digression on long bonds and their risks.

So, the short answer is that US large company stocks did reasonably well, but poor international stock performance offset much of those returns, and bond returns further dragged down performance.

For what it’s worth, the funds we typically use in most client portfolios kept pace, and in several cases, outperformed their respective benchmarks. For example, the two US large company funds we use, the DFA US Large Company[4] and DFA US Large Value funds, posted returns of 14.5% and 10.91%, respectively, both beating the Dow in the process. The DFA US Real Estate fund also outperformed its benchmark, the Dow Jones US Real Estate Index, 33% to 27%.

Why Hold Internationals at All?

If internationals have performed so poorly of late, why hold them at all? The most compelling reason is diversification, which is a tacit acknowledgement that, despite how well any particular asset class has done in the past – recently or otherwise, we don’t have any idea which ones will do well in the future. So, yes, US stocks have outperformed internationals over the last year – and the last few years, but if you look back long enough, you’ll see that that hasn’t always been the case. Over the last 15 years, for example, five of the six international funds we use have outperformed the S&P 500 by between 1.5% and 6% per year, and most of that outperformance came from 2003 – 2007, when international markets surprised many after several years before that of relatively weak performance. For clients who have been with us that long, it’s quite likely that without internationals in the portfolio 15 years ago, there would have been a lot less money in the pot at the start of 2014.

The recent outperformance of the US is analogous to a few other times I can recall: the meteoric rise of technology stocks in the late 1990s; the run-up of gold in the early 2000s; the overheated energy sector in 2008 when oil hit $145/barrel; and the strong performance of bonds in 2008-9 when stocks were crashing. If you’re inclined to ask, “Why don’t I put more/all of my money in the US market today?”, it might be worth asking what the results would have been had we followed that line of reasoning in the past: What if I had put all/more of my money in tech stocks in 1999? What if I had invested more heavily in energy in 2007-2008? What if I had sold my stocks when they had plummeted and bought the better performing bonds instead? In hindsight, the answers are generally clear and obvious, but it’s easy to lose that perspective in the heat of a hot market (or at least one that’s hot, relatively speaking, compared to almost everything else on the planet.)

Finally, one other comment on internationals: I know that some will think – and perhaps understandably: Will those other countries ever get their act together? And why should I wait for their substandard stock market returns while I wait for them to get it together – especially the more socialistically leaning ones? It’s a fair question, but surprisingly, there is surprisingly little evidence that a country’s economic performance or its political leanings have much effect on its stock market performance. To wit, take a look at the table below of stock market returns for various countries from 1971 – mid-2014:

As I look at this chart, I have a few thoughts:

  • First of all, the market performance of Germany, Canada, France, Norway, Switzerland, and the UK are not that far from that of the US – all within about 0.25% per year in average annual returns.
  • Secondly, note that how socialistically leaning a country is doesn’t seem to have any predictable effect on long-term stock market performance: Sweden and Denmark both have huge social welfare programs and a much higher tax structure than the US does, and yet their stock markets have delivered an eye-popping 2.5% to 4.3% per year in additional returns above the US market. Wow!
  • Even France with its anti-business sentiments and draconian regulation has lagged the US by only 0.3% per year AND, even more amazingly, its long-term market performance has been slightly higher than the ever-industrious Germans. Another wow!

The point of all of this is, of course, is not that these particular countries will outperform the US market going forward (although they may); the real point is that we’re often surprised by the performance of both countries and / or investment categories and, even with the benefit of hindsight, it’s not always clear which one will be or would have been the clear winner, political turmoil and policies notwithstanding.

Finally, take a look at the following chart, which shows the major asset classes and their performance year-to-year over the last 15 years. (The chart hasn’t been updated for 2014 yet, thus the 2013 endpoint.) For each year, the asset category boxes are ranked from best performing at the top to worst performing at the bottom. I’ve drawn a red line through the S&P 500 and have highlighted in a green box around every occurrence where one of the two included international categories (International Large and Emerging Markets) have outperformed the S&P 500. With this visual, it’s very easy to see that US stocks and, specifically, US large stocks, aren’t always the best game in town. (Apologies for the slight blurriness of the image.)

Looking Forward

None of this means that next year will be the year of the international stock fund. It may or may not be, and betting too heavily on any one asset category or country – especially when it’s as expensive and popular as the US market is right now – is usually an ill-advised strategy. For most clients somewhere in the neighborhood of 50% to 60% of their equity holdings are in the US market – US large, US small and US real estate included – and in my opinion, that’s enough chips for most people to have on one number. However, if this is something you’d like to talk over in more detail as it pertains to your specific situation, I’d be more than happy to do so. Just let me know.

In the meantime, I wish you a very Happy New Year and hope it’s a year filled with health, happiness and prosperity . . . and, as always, please let us know if there is anything we can do for you.


[1] Based on the following indices (in order listed in table above): S&P Goldman Sachs Commodity / Energy Index; S&P Goldman Sachs Commodity Index; MSCI European Index; Barclays Intermediate Term Global Bond Index; MSCI Pacific Index; MSCI Emerging Markets Index; S&P Goldman Sachs Gold Index; Barclays US Treasury 1-3 Year Index; Barclays US Treasury 3-7 Year Index; MSCI All Country World Index (ACWI) All Cap; Russell 2000; Dow Jones Industrial Average; Dow Jones US Real Estate Index; Bank of America/Merrill Lynch US Treasury 20+ Year Index. In the case of US indices, total returns are reported. In the case of international indices, returns are reported on a US dollar basis (after currency exchange differences) net of foreign taxes withheld on dividends.

[2] While US stocks are expensive, bonds – especially long term bonds – are at the tail end of a 30 year bond bull market and are exorbitantly priced by any historical measure. While the returns this year were very attractive, l believe the primary role of bonds in a balanced portfolio is stabilization against the inherent volatility of equities. Long term bonds, especially at current prices given low interest rates, are not in any way defensive at this point and when rates rise, as they inevitably will, there is likely to be a bloodletting in long bonds, which would largely defeat their defensive purpose. Remember the old adage, “Anything that can go up 27% in a year . . .”, and while that’s expected in an equity portfolio and the reward has been commensurate, very few would expect that kind of volatility from bonds, even long Treasuries.

[3] Keep in mind that the percentages above are expressed as percentage of the equity portion of a portfolio; since most clients don’t have an all equity portfolio, the percentages expressed would be percentages of whatever portion of their portfolio is in equities. So, for example, a client who has a 60% stock or equity might have 40% of that 60% in US large company stocks, and not 40% of their overall portfolio in US stocks.

[4] Keep in mind that the percentages above are expressed as percentage of the equity portion of a portfolio; since most clients don’t have an all equity portfolio, the percentages expressed would be percentages of whatever portion of their portfolio is in equities. So, for example, a client who has a 60% stock or equity might have 40% of that 60% in US large company stocks, and not 40% of their overall portfolio in US stocks.