Financial markets, however, especially here in the U.S., don’t seem phased. Indeed, stocks have moved to new highs even as interest rates dropped to new lows. Much has been made of the apparent disconnect between this outperformance and the turmoil around the world.
But I would argue that these events—not to mention the ongoing depreciation of the Chinese currency, the new weakness of the yen, and the Italian banking crisis—are, in fact, connected. They all highlight one big commonality: the strength and attractiveness of the U.S. for investors.
Despite our many domestic concerns, the U.S. remains the only truly stable and economically sound power in the world, and investors are responding to that. The drop in U.S. rates reflects increasing international demand for U.S. bonds. Why? Because the U.S. economy is actually growing, and our rates are higher than those of other countries. Because our politics are stable (no matter how it may appear to us). Because the value of the dollar, though it will continue to bounce around, is assured over the longer term—unlike, say, the euro or the yuan.
What does this mean for our portfolios? In the short term, it should mean that U.S. outperformance continues. The S&P 500, for example, has done extremely well on a relative basis over the past several years. American companies have benefited from the (relatively) strong U.S. economy, from a cheap dollar over much of that time frame, and from a strong competitive position. That is likely to continue for a while.
In the medium term, though, other countries will likely bounce back. Brexit, for example, has not done the damage predicted. It might yet, but it might also work out to the benefit of both Britain and the EU. The EU has finally started to grow, and it may be forced to implement some serious structural changes that could make it more competitive and better for companies to operate in. China is in the midst of a transition, with all of the risks that entails, but eventually, it will be better positioned to resume faster growth.
At the same time these countries may be doing better, the U.S. may be doing worse. It’s certain that we will have a recession at some point. When that happens, other areas will become more attractive for investors, and U.S. assets will cede pride of place.
Even as we take comfort in the fundamental soundness of the U.S. economy and its solid position in the world, we shouldn’t get caught up in the current outperformance. The U.S. looks good now, but it won’t always be the best investment option. Geographic diversification remains the best way to protect ourselves against that turn of events, even when it seems like the U.S. is the only place to be.
I’ve made the argument for diversification many a time. With markets hitting new highs, and risks around the world intensifying, it makes more sense than ever to keep a globally diversified portfolio.