Is International Stock Exposure Necessary?

Not if your system is driven by volatility in an index of multinational companies.

In the Open Discussion forum of The Kelly Letter subscriber site, Ari posted:

I’ve noticed that the 3Sig, 6Sig, and 9Sig growth plans [as well as the Income Sig plan] have no exposure to equities outside of the US.

I’m a big fan of the letter’s guidance, but this consideration has me worried about ignoring international opportunities for the rest of my investing years. What are your thoughts on developed and emerging markets outside of the US? Could it be worth adding something like VXUS [Vanguard Total Intl Stock], VEU [Vanguard FTSE All-World ex-US], or ACWX [iShares MSCI ACWI ex US] to our 3-6-9 allocations?

Clearly, there are many benefits to allocating at least a small portion of one’s portfolio to stocks in the ex-US (outside of the United States) category. For example:

Diversification: Holding a mix of domestic and international assets can help spread risk. Different regions may experience economic cycles and market movements independently, reducing the impact of adverse events in a single market on the entire portfolio.

Growth Opportunities: Some international markets may offer attractive growth opportunities that are not available in the US. Investing in ex-US stocks allows investors to participate in the economic development and growth of other countries and regions.

Industry Exposure: Different countries may have varying economic structures and dominant industries. Investing globally can provide exposure to sectors and industries that might not be well-represented in the US market.

Valuation Opportunities: Valuation levels of stocks in different markets can vary. There may be times when stocks in certain international markets appear more attractively priced compared to US stocks, presenting opportunities for value-oriented investors. At the present, US markets are incredibly overvalued relative to undervalued ex-US markets.

Geopolitical Risk Mitigation: Investing globally can help mitigate unforeseen geopolitical risks. Economic and political events that affect one region may not have the same impact on another. A well-diversified global portfolio may be more resilient to geopolitical uncertainties. US markets are dominant now, but that doesn’t mean that they have always have been — or will continue to be indefinitely.

Thank you for considering my inquiry. I came to the letter as a former Boglehead, so I hope you can all understand why international exposure might be an importantly consideration for me. However, I’m more than happy to hear persuasive, powerful counterarguments.

Thank you, Ari, for your thoughtful inquiry.

While you accurately summarize the main arguments for diversifying outside of the United States, several objectives of doing so hamper our 369 plans.

The plans thrive on volatility. They want ups and downs, not a smooth path. Diversifying across multiple stock indexes in the same plan would dilute its exposure to the highs and lows of a single index. It’s more profitable over the long run to take buy and sell signals from a jagged price line than from a smoothed line comprised of multiple indexes, some that zig when others zag. That produces a flatter line, and less opportunity to sell highs and buy lows. It would reduce the benefit of our ability to sell more at higher highs and buy more at lower lows, which is what has driven our performance above the market’s. Muted highs and lows don’t work as well. There is simply not as much differential to take advantage of.

This is a key distinction between the letter’s approach and traditional money management. We deliberately eschew diversification for the purpose of getting full exposure to volatility. We want the highs and lows, not to flatten the line.

I would further argue that our indexes contain plenty of international exposure via multinational companies, such as Amazon, Apple, Microsoft, and others. Their need to translate overseas revenue into US-dollar-based profits also hedges against currency fluctuations, with some of them working for and others working against us.

Valuation has proved unhelpful in the modern tech economy. For example, Amazon has been “overvalued” for its entire run to the stars. Clearly, something is wrong with traditional valuation metrics. You mentioned the US being incredibly overvalued, but I’ve heard this almost every year since the advent of the internet. I heard it when we started the 9Sig plan in 2017, but we started it anyway and the plan has now grown more than 8x in seven years. Now I’m told that US tech is overvalued again. More often than not, winners keep winning.

Geopolitical risk is best mitigated with multinational companies of the type that comprise the indexes we use. When a war breaks out, or some other localized crisis, multinational firms fare better than local ones. I would rather own the likes of Nasdaq 100 components than regional, foreign companies.

Note that it is possible to create an International Sig plan using a non-US stock index for the growth portion. In some time frames, such a plan would fare better than its US counterparts because occasionally foreign indexes outperform US indexes. I have helped some non-American subscribers create local plans because they lacked access to the US funds we use in our plans.

However, there’s no need for the letter and its predominantly American readership to diversify in order to include foreign markets, and no foreign market has demonstrated a long-term advantage over the US. Among the ones that outperformed the US in some past time frames, we cannot be confident that they will do so in future time frames. We should simply stick with the indexes that keep working for us.

Thank you, again, for the thoughtful inquiry. I hope this answer provides you with confidence to continue running the plans as they’re designed.