Which Country Will Outperform? Here’s a Better Way

Investment opportunities exist around the globe, but the randomness of stock returns in different countries makes it almost impossible to predict which country’s stock market will outperform others. How should you manage that kind of uncertainty?

Approximately half of stocks globally represent companies outside the U.S. At the end of 2020, the stock market globally included more than 15,000 companies worth an aggregate $90 trillion, with about half (56%) of the value of all investible stocks in U.S. companies. The other half is comprised of developed ex U.S. and emerging stock markets. Most American investors tend to avoid non-U.S. stocks.1

Thinking how investors vote with their money after considering costs, expected return and risk, diversification, and their own tastes and preferences toward holding different investments, it’s useful to think in terms of countries allocated by percentages.

First, it’s a challenge, at best, to predict a country’s returns (much less those of a stock) by looking at past results, as shown by the performance of developed global markets (see Exhibit 1). In the past 20 years, annual returns in 22 developed counties varied widely from year to year. (Each color represents a different country, and each column is sorted top down, from the highest-performing country to the lowest.)

Exhibit 1: Most Favored Nations

chart grid of Most Favored Nations - Annualized Returns

Past performance is no guarantee of results. In USD. MSCI country indices (net dividends) for each country listed. Does not include Israel, which MSCI classified as an emerging market prior to May 2010. MSCI data © MSCI 2021, all rights reserved.

No predictable pattern is discernable in return by country from year to year. Each year, the best performing countries (with their underlying asset classes) can be found in different regions around the world. No evidence suggests that even professional investors can consistently identify in advance which countries will be that year’s outperformers.

Since 2000, among 44 developed and emerging markets countries, the U.S. market has never been the top performer. Some might find this surprising, given the size and reputation of the U.S. market. A counterintuitive example also may be found in emerging markets, where a prosperous country like China was the top stock performer among emerging market countries only once (2006).

Two examples from Exhibit 1 make the point well:

  • Austria posted the highest return in developed markets in 2017—but the lowest the next year.
  • The U.S. ranked in the top five for annualized returns over the entire 20 years. Yet it finished first in developed country rankings only once. In nine calendar years, the U.S. was in the lower half of developed market performers.

Global Diversification for Informed Planning

A diversified portfolio will never be the best or worst performing compared to its many components. Likewise, compared to performance of individual country components for planning an informed strategy, a diversified global portfolio can never be the best or worst performer in any year simply because it is a weighted average of those countries. The fundamental purpose of diversification is not to get to pick winners, but to offset extreme negative returns and increase the reliability of successful long-term outcomes by automatically including stocks that will happen to have high positive returns that year.

Investors should be very cautious about reducing global diversification in response to recent outperformance of a particular country, especially for U.S. investors with a strong home bias. Global portfolios will have periods of higher returns that a home country-specific portfolio will have. Attempting to predict when these periods will occur is likely to be a costly exercise in futility.

Results can change dramatically from year to year or decade to decade even in countries with a history of above-average returns. For example, since 2010, U.S. markets have been very strong performers and generally delivered higher returns compared with a global portfolio strategy and many other countries.

However, the prior 10 years — referred to as the “Lost Decade” for U.S. stocks — showed very disappointing results for those who concentrated in once popular American growth stocks. Over the 10-year period from 2000 to 2009, U.S. large stocks, as represented by the S&P 500 index, experienced an average negative return of -0.9 percent annualized, or a loss of 9% cumulatively. Adjusted for inflation, that was equivalent to -3.4 percent annualized or about -37 percent cumulatively.

Chasing media-hyped stocks or countries in response to a country’s or asset class’s recent performance — especially for families nearing or at retirement tempted to make U.S. stocks bets in hopes of even higher returns will make up for a lack of sufficient savings, are courting disaster.

Planning a Successful Conclusion

A successful financial experience need not depend on predictions or gurus as to which countries or asset classes will deliver the best returns for the next quarter, the next year, or even the next decade. Why? Because holding a dimensionally diversified portfolio of stocks from many markets worldwide — as opposed to a handful of countries or concentrating in just one — positions you to capture higher returns somewhere in the world wherever and whenever they happen. That outperformance will offset lesser performance that naturally occurs somewhere.

A truly informed globally diversified portfolio can provide more reliable outcomes for achieving retirement and legacy planning goals and give you greater peace of mind.

1.In US dollars. Market cap data is free-float adjusted and meets minimum liquidity and listing requirements. Data provided by Bloomberg. The World’s 10 Largest Stock Markets (October 29, 2020) Visual Capitalist Datastream, www.visualcapitalist.com/the-worlds-10-largest-stock-markets/