What About International Stocks?

Given the appreciation in the US stock market, you should take this opportunity to review your accounts to see if any re-balancing of your portfolio is appropriate. If it has been some time since your last review, you may find that you are underweight in international stocks. While the mention of international stocks may not be appealing, due to the on-going European issues, we would like to provide some context for why you may want to reconsider.

Buy Low, Sell High

"Buy low, sell high" is the quick, common phrase that you always hear when someone is explaining how to be a successful investor.

Over the past two years there has been a wide difference between the performance of US stocks and international stocks. The US stock market, as measured by the S&P 500, has produced a total return over the past two years of nearly 35 percent. On the other hand the international stock market, as measured by the MSCI EAFE Index, is up only 5 percent. That is a difference of nearly 30 percent in just two years!

This divergence began last summer when the European crisis came to the forefront of investor's concerns. Since then US stocks have roared back while the rest of the world's stocks have largely remained on the sidelines.

Concerns are Everywhere

Here are a few of the concerns we have been following in the international markets:

-Europe's continuing financial crisis
-Europe's recession
-China's slowdown
-Brazil's slowdown

Many of these issues are intertwined. Brazil’s slowdown has been impacted by the reduced demand from China for Brazil's natural resources. China's slowdown has been impacted somewhat by the on-going fiscal crisis in Europe, which has reduced the demand of exports from China to Europe. Therefore, better than expected results out of Europe, should they get their act together quicker than expected, may have a domino effect on some of the other lingering concerns. If this happens soon, you would expect the gap in performance difference to narrow quickly.

What about Europe?

While we do not know precisely how the European crisis will play out, the markets are already pricing it to be pretty ugly. With the US stock market outpacing the international market by 30 percent over the past 24 months, a pretty significant discount exists for international stocks. This does not mean the volatility is over for international stocks. However, for long term investors, the opportunity to buy an entire asset class at a 30 percent discount, relative to the US stock market, should be something all investors pause and consider.

Looking at the valuation of international stocks as of June 30, 2012, the MSCI EAFE Index, which tracks international stocks, had a forward price-to-earnings ratio of 10.5, which is a pretty attractive ratio from a historical standpoint. The U.S. stock market has a forward price-to-earnings ratio of 12.4. At the same time the international index has a dividend yield of almost 4 percent, which is a nice payout if you compare it to the U.S. stock market index (S&P 500), which is paying out a yield of just over 2 percent.**

Another consideration is that many companies headquartered in Europe do a significant amount of business outside of Europe. These company stock prices have been punished due to where their buildings are located and not where their revenues are generated. We believe these opportunities make active, international stock mutual fund managers more attractive today. An active manager has the ability to review all the international markets, buy at depressed prices, and avoid regions that appear unattractive or too risky.

So Now What?

International stocks make sense for long term investors as the US makes up less than half of the total world’s stock market based upon market capitalization**. While we do not feel that investors need to have more than 50 percent of their account invested in international stocks to match the world capitalization ratio, we do believe it is prudent to allocate 20-30 percent of the stock portion of your portfolio to non-US stocks.

It is likely that over the past 12 to 24 months your domestic stock investments have outperformed your international stocks. Now may be a good time to review your portfolio and consider taking profits by selling some of your US stocks. If your international allocation is less than appropriate for you, the proceeds can be used to add to your international exposure. Remember the best advice for long-term investors is to "buy low and sell high."

*Source: MSCI, FactSet, and JPMorgan Asset Management
**Based upon information from JPMorgan Asset Management

This article was contributed by Ryan Collier, an Investment Manager at Bedel Financial Consulting, Inc.

Elaine E. Bedel, CFP, is president of Bedel Financial Consulting, Inc., a wealth management firm providing fee-only financial planning and investment management services for individuals, consulting services for corporate retirement plans, and investment advisory for institutions and endowments. She is the author of "Advice You Never Asked For... But wished you had!" available on Amazon.com. For more information, visit their website at www.BedelFinancial.com or email to ebedel@bedelfinancial.com.