|
Page 5 of 8
The Implications For International Investing
As trade barriers have subsided, large inter-country trading blocs have emerged, and financial market restrictions have relaxed, world equity markets have become increasingly integrated. This has led to rising equity market correlations, a fact well documented by Vanguard research.[2] The global financial crisis of 2008 has led to even higher correlations as stock markets around the world have fallen markedly in value. These recent events may tempt investors, as they have in the past, to conclude that the long-term case for international investing—portfolio diversification—is invalid.
To be sure, the long-term diversification benefits of international investing can be obscured by short-term economic and financial factors such as bear markets, financial crises, and recessions. Indeed, Figures 9 and 10 document the well-recognized pattern that short-run correlations among international equity markets tend to be asymmetric: correlations across national stock markets are higher when the U.S. stock market declines significantly (Figure 9), and when the U.S. economy is in recession (Figure 10).
Figure 9 illustrates that when there is a bear market in U.S. stocks, other markets tend to experience bear markets as well, increasing the correlation between markets. Tokat (2006) shows that since the early 1970s more than 70% of developed countries have experienced bear markets in stocks simultaneously with a U.S. bear market. The high international stock market correlations during U.S. bear markets help to explain why global contractions tend to be more highly synchronized across countries than global expansions.
The higher short-term correlation between U.S. and international stock markets may seem to weaken the case for international investing, validating the oft-heard complaint that "diversification disappears when you need it most." We stress, however, that this stylized fact does not invalidate the long-term benefits of global equity diversification. For instance, Figure 9 shows that even during U.S. "tail events" (such as when the monthly return on the U.S. stock market is down more than one standard deviation from its historical average), international equity market correlations with the United States do not equal 100%, on average. A good example is the case of a worldwide commodity-price shock because of falling oil supplies. While an oil-price shock will tend to adversely impact the markets for industrialized (commodity-importing) countries, such an oil shock may benefit (on a relative basis) certain commodity-producing countries.[3]
Most importantly, Figures 9 and 10 reveal that the diversification benefits of international investing are most apparent once stock market volatility subsides and recessions end. Indeed, as financial crises subside, the economic and financial market performance of countries will differ because of their heterogeneous economic structures, capital-flow sensitivities, commodity-price exposures, and varied monetary and fiscal policy responses to crisis events.
|
RSS
