Investing abroad has been a fundamental part of institutional investor’s strategy for quite some time now, but now globalization of financial markets has given the traditional investor a chance to take advantage of the opportunities abroad. Over the last few years, especially since the U.S. recession in 2001-2002 when U.S. equities struggled, investors have looked for opportunities elsewhere.
Many have migrated to international investments due to a great deal of hype regarding their ability to add value and diversification to traditional portfolios. If you haven’t added international investments to your portfolio, you are already behind the curve.
The globalization of international financial markets has provided liquidity for smaller investors to enter international markets that were once considered taboo because of their high risk. Increases in open financial markets, financial product innovation and technological innovations in the telecommunications industry have played important roles in the globalization of financial markets. Not only do these innovations make it easier to provide sound investments for investors, but it increases the ability for the less-developed nations to “catch up” quicker than previously thought possible; therefore, increasing the opportunities available abroad.
Some international markets have a higher degree of risk because of political instability, lack of financial infrastructure and vulnerability to large swings in the nation’s economy. Therefore, international markets have been viewed as risky and only those who are able to ride out the highs and lows involved with an investment in a lesser known market would actually invest in these markets. However, as time has passed, the once “too risky” international markets have become much more mainstream as a diversification tool for traditional investment portfolios.
As international investments become mainstream, there will be a time where these nation’s economies are as stable as the United States’ today. There will be no denying the need for international investments in a well-balanced and diversified portfolio.
Even though the progress and maturity levels of international markets have increased substantially, the U.S. is not the only place to put your hard earned dollars to work. Some of the largest economies in the world still have a lot to offer. So who dominates the world’s economy? This should be an obvious answer; the U.S. has the largest economy in the world and therefore also provides the largest financial markets (see “Largest World Economies). The U.S. market’s depth makes it a relatively safe investment; however, this could also mar the overall performance of certain investments. Large can be good, but too large of a pool can also be a detriment to opportunities due to of economies of scale. Is this the reason why U.S. markets have underperformed?
Over the last few years, international markets have been touted as a great diversification tool for portfolios, but have they provided the diversification they expect? Let’s take a look at figure 1.1 below. This chart consists of five of the world’s largest economies and their stock market’s performance over the past two years. As you can see from this chart, every market has outperformed the S&P 500. You probably only took one glance before you noticed that the trends and chart patterns look very similar between all of the markets.
The trends and patterns you see between these markets are because each market truly feeds off of one another. As these markets continue to evolve with new technologies, innovative financial products and international access to these products they may become even more intertwined. Remember, this chart only highlights the last two years of performance. These nations have been going through different economic conditions over that time period which effects their overall performance. For those looking to increase their exposure abroad and trade, these four international markets are the least risky and could be a great addition to any portfolio.
In conclusion, we can see that the world’s markets are truly intertwined. Not only has their performance been in tandem, but one country’s problems seem to be global; affecting several markets in its path. It will be interesting to see what happens over the next few years and whether the correlation remains or if one market will begin to differentiate itself from others. Another interesting analysis would be to analyze the rise of developing country’s financial markets. Developing countries are driving along at a rapid pace and we could see some great things out of countries like India, Mexico and Brazil.
by Charlie Santaularia
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