Time To Increase Foreign Holdings

What goes down might come up.

Foreign stocks had a losing year in 2014 — but they could juice your portfolio’s performance if U.S. stocks falter, as many folks now fear. Here are four reasons I’m inclined to up my allocation to both emerging markets and developed foreign markets:

1. U.S. stocks have outperformed foreign shares over the past five, 10 and 20 years, and the margin of victory has been huge. If you had invested $1,000 in early 1995, you would have more than $6,300 today if you had bought the Russell 3000 index, which offers broad exposure to the U.S. market — but less than $2,800 if you had invested in MSCI’s EAFE (Europe, Australasia and Far East) index, based on data through January. That lackluster performance might scare off some investors, but it should intrigue anyone looking for a bargain.

2. U.S. stocks now account for more than half of global stock market capitalization.“Obviously, the U.S. is not half of the global economy,” says William Bernstein, author of the book “The Investor’s Manifesto” and an investment adviser. “That just doesn’t make sense.”

3. The dollar has soared in the currency markets, hurting U.S. holders of foreign investments, because those investments are worth less when converted back into dollars.I have no idea what will happen next to the dollar. But I’m a lot happier investing overseas at today’s exchange rates, with the dollar worth so much more overseas, than at those that prevailed six months ago.

4. Most important, many foreign markets are cheaper than U.S. stocks based on market yardsticks such as price/earnings ratios, dividend yields and price to book value. Those lower valuations aren’t surprising: Emerging markets involve greater risk, while there are big concerns about economic growth in Europe and Japan.“To buy low, you have to be willing to tolerate bad news,”Bernstein warns.Foreign markets’ cheaper valuations don’t guarantee higher returns, especially over the short term. Even over 10 years, valuations — as reflected in P/E ratios — drive only 35% or 40% of returns. “That means 60% to 65% is not dependent on valuations,” says Vanguard Group’s Francis Kinniry, a principal in the firm’s investment-strategy group. “Yes, valuations are helpful, but I think people overplay it.”