Patriotism is alive and well in my conservative West Virginian family. I saw them for a surprise visit over the Thanksgiving holiday.
“Your grandfather didn’t want a GM since they took the bailout money,” my grandmother shared as the reason for the new Ford Escape in their garage — by exclusion, suggesting those were the only two automakers they’d considered.
After dinner I overheard my cousin’s uncle exclaim, “Hell, if I could just scrape that emblem off and slap on a Ford I’d love that car.” He was referring to his wife’s Subaru, which she’d brought into the marriage against his wishes, though he would later learn how it made it out of their snowy mountainside driveway far better than his F-150 does.
Even my grandmother’s kitchen knives are American-made, from Amish country in nearby Ohio.
And here I am, feeling like the black sheep with my German and Japanese cars… German and Japanese kitchen knives… and a boatload of foreign stock holdings, including, yes, German and Japanese companies, that I’m guessing my relatives wouldn’t care to own if you gifted them the shares!
To each his own, of course. And I’m not saying there’s anything wrong with being patriotic, or that I’m not patriotic myself — I have a lot of love for our great country.
But it’s just really interesting to me to see how deeply patriotism can run, and how great of an influence it can have on people’s decisions in both overt and subtle ways.
On merit, my cousin’s husband had positive things to say about that Subaru. But because of his America-centric bias, he still swore he’d never buy one himself.
That’s fascinating to me in and of itself since I see essentially the same thing play out among U.S. investors, who have proven to hold an irrational and economically-suboptimal affinity for U.S. stocks over foreign stocks.
Home Country Bias
Call it patriotic or call it lazy, most people stick close to home when it comes to investing.
This so-called “home country bias” is a phenomenon too big to ignore.
It’s pervasive across time and geography. And even though it makes investors feel all warm and fuzzy inside, it generally tricks us into accepting lower returns and higher volatility from their domestically-tilted portfolios.
What is this home country bias phenomenon?
Investopedia explains it as well as I could, with some emphasis added on my part:
Investors’ natural tendency to be most attracted to investments in domestic markets. Investors tend to focus more on their home markets and the companies that do business within these markets, because they are familiar with them.
These investors do not strongly diversify their portfolios with international market securities, which could become a weakness for their portfolios if their home-country suffers serious economic decline.
Home country bias affects all investors, all around the globe.
U.S. investors routinely over-allocate to U.S. stocks…
Canadian investors over-allocate to Canadian stocks…
Australian investors over-allocate to Australian stocks… so on and so forth.
But today’s message is a warning targeted squarely to U.S. investors.
You see, U.S. stocks have outperformed foreign stocks over the current market cycle, whether you look back to the 2007 top or the 2009 bottom. But you shouldn’t expect your good fortune to continue forever!
Just because U.S. stocks have outperformed for the past decade does not mean U.S. stocks have always outperformed, nor that they will always outperform.
In fact, the outperformance of U.S. stocks, over non-U.S. stocks, in general, is very cyclical. Take a look at this chart from Vanguard:
Going back to 1970, you can see how the outperformance of U.S. stocks waxes and wanes over time.
Sometimes U.S. stocks lead the pack. Sometimes foreign stocks.
Sometimes U.S. stocks become overvalued, relative to foreign stocks, and vice versa.
Sometimes “sentiment” leans toward the U.S…. other times toward foreign markets.
Regardless the specific drivers of these cycles, the mean-reversion nature of outperformance is exactly what we should expect from a capitalist, global economy. Competition keeps the winners in check over the long run.
But it also represents a dangerous blind spot for investors who have ridden the high of a home country bias advantage a little too long.
I’m talking to you, U.S. investors!
A Dangerous Blind Spot
It’s easy to get lulled into thinking U.S. stocks will always outperform — particularly after a good, long run, and especially after a decade of outperformance! But as the chart above shows, over-allocating to U.S. stocks is not the best strategy all the time.
Of course, it’s a significant challenge to precisely time the tops and bottoms of the U.S./foreign outperformance cycles. And many advisors would simply suggest building a diversified buy-and-hold portfolio, with appropriately-sized allocations to many markets — U.S. and foreign.
I prefer I more dynamic approach — one that involves adding foreign market exposure for just a few months at a time… only when specific foreign markets are highly-likely to outperform U.S. stocks.
And I use my Cycle 9 Alert algorithm to identify those foreign market “sweet spots,” which can sometimes last for just a few months at a time.
Right now, Japanese and German stocks are in one of those sweet spots.
Despite the continuing trade war that’s largely between the U.S. and China, the Japanese and German markets have outperformed U.S. stocks since August.
I even recommended a specific “bullish Japan” play to my Cycle 9 readers in September, and we’ve been able to ride that trend for better than 70% profits — and counting. (The trade is still open!)
And my latest Cycle 9 recommendation is a “bullish Germany” play — there’s still time to get in.
I can’t say for sure whether Japanese and German stocks will outperform U.S. stocks over the next ten years — reverting the United States’ recent, decade-long run.
But I do know that investors who are blind to home country bias… those who are always over-allocated to U.S. stocks… will someday be sorely disappointed.
And I know that investors who stay flexible; those cunning enough to bet on foreign markets when the time is right — as it is now — will be nicely rewarded.
No matter what you do, don’t get lulled into thinking your domestic market is always the best game in town. Half the time, it’s not!
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