By Lyn Alden
Many investors focus heavily on individual security selection, but proper asset allocation is where you get most of the bang for your buck.
There’s almost always a decent value to be found somewhere in the world. And many asset classes tend to revert to their mean- if one country outperforms another country over the course of a decade, then it’s often the opposite case next decade. This is why diversification is so critical.
Right now, the cyclically-adjusted price-to-earnings (CAPE) ratio of the S&P 500 is over 30. The average book value multiple of the S&P 500 increased more than 50%, from 2x to over 3x, in just the last five years. The ratio of total U.S. market capitalization to GDP is about 135%.
All of these metrics compared to historical norms suggest that the U.S. stock market is overvalued by 25% or more. This isn’t necessarily irrational overvaluation either, because a historically long period of extremely low interest rates have left investors with very little choice other than to pile into equities if they want decent returns. Interest-bearing investments have been hard to hold for a while with such low interest rates.
And investors are indeed piling into the market. NYSE margin debt is at an all-time inflation-adjusted high. The chart in that link shows that investors tend to enthusiastically load up on margin debt during market tops, and fearfully de-leverage themselves during market bottoms, which is the opposite of what rational behavior would be.
The world’s most successful investors of course tend to do the opposite; they get cautious when the market is highly valued. Warren Buffett has tripled his cash position over the last four years to $100 billion. Seth Klarman, one of the most successful hedge fund managers ever, is currently holding 42% cash and is giving billions back to investors because he can’t find as many good values as he would like right now.
International ETFs are Cheap
By just about every metric, the U.S. stock market is one of the most expensive in the world.
This is partially justified due to our large technology sector and our highly diversified and robust economy, but only to a certain extent. Now that we’re more than 8 years into the third-longest U.S. economic expansion in U.S. history, it’s important to be cautious.
Fortunately, some international markets are cheaper, and have already gone through significant corrections.
Here’s a color-coded chart of the various market valuations in the world, and you can sort it by various metrics on the original page:
Valuation Chart for International ETFs
Source: Star Capital
While I still hold considerable exposure to U.S. equities, I’ve been increasing my international exposure over the last few months to diversify away from the American stock market and into more reasonably-valued and higher-yielding foreign markets.
5 International ETFs Worth Buying
Low cost index funds provide plenty of easy ways to invest globally, and here are five that I consider some of the most useful for diversification. I don’t necessarily recommend buying all five; it depends what your current investments are, and most likely a subset of these can help you round out your diversification by quite a bit.
Vanguard Total International Stock ETF (VXUS)
Expense Ratio: 0.11%
Current P/E Ratio: 15.5
Top 3 Countries: Japan, UK, Canada
If you could only buy one international ETF, this would be one of the top contenders.
With exposure to developed and emerging markets for a very cheap cost, it’s a one-stop shop for international exposure.
The only real downside of the fund is that a full 17% of it is invested in Japan, which has a declining population and has had a 30-year bear market. It’s one of the few markets where long-term investing hasn’t worked out; the market is lower today than it was in 1989. That’s one reason I’m not a fan of pure market capitalized weighting in international funds; the result is a heavy concentration in the largest countries rather than more even diversification across the world.