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What to do if you’re queasy about the US stock market [Members]
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> into an ex-US global tracker
That’s all very well, but I have yet to find something aimed at a non-US-market. The index FTSE All-World ex-US and the ETF exists – VEU. No, not that EU, this is marketed at US good old boys, not effete yurpeans (or non-yurpeans). I haven’t found anyone selling that index to Brits, presumably on the principle nobody would be mad enough etc etc.
I want this, to split some VWRL I have to sell to harvest this year’s CGT allowance, and perhaps boot the VUSA element into next year’s ISA and leave the deadbeat FTSE All-World ex-US ETF in the GIA to deprive the taxman of revenue by concentrating the profitable part in the ISA.
So it’s not quite going along with the thesis of this article, but abusing the principle for different aims.
UK ISA to the rescue? Some UK gov bonds and shares to dilute US? For Cap gains harvest I’m currently cashing out into 5% cash rather than switching to a different global tracker.
My plan, is to keep my equity asset allocation as is (65% in my ISA), but have this to from 65% VWRP to 55% VWRP and 10% VHYG.
This will do a little bit to reduce my overall US equity exposure slightly, and bring a slight value tilt to my ISA.
Lots of interesting information here but does it alter the underlying premise of just investing in the world stock market index in stocks and bonds and leaving your investments alone-well not for me
The delight of a total stockmarket tracker is that it automatically adjusts to the index -so if you are worried about a US preponderance then the tracker will adjust as the US goes off the boil (when ever that is) without any worries from the investor getting his hands dirty performing market timing/adjustments etc-all those great excuses for tinkering !
Regular market drops in equities and bonds and their subsequent recoveries are a constant market lesson that reinforces the fact that nobody knows anything !
Having just sat through many of these ups and downs( with my selected Asset Allocution in place ) without doing anything at all -over my 78 years -it does seem to be a successful if very boring investment policy
Betting against the US of course has been a losing investment plan for many decades-so far!
xxd09
@ermine — Eek, really? I guess this is what happens when the stock picking junky makes assumptions about funds.
Oh well, pending a solution from anyone else I suppose you could just buy a European and an Asian tracker and get much the same. I’m more cavalier about this stuff though than purists I realise.
Ridiculous there’s no ex-US tracker when it’s 65% of a standard world equity fund though!
I tried to reduce my exposure to the US, but as Ermine mentioned – there’s no fund that does that in the UK. So I ended up getting two different funds, one for european stocks and another for emerging markets.
I think it’s a valid decision for passive investors, because – entirely consistent with acknowledging that we can’t reliably pick winners and losers, there are many risks which are not directly related to market-capitalisation.
To explain – consider that every $ invested carries with it a “performance risk”. This is distributed in a similar way to market capitalisation – there are far more $$$ in the US, therefore the risk is larger in the US because it actually has more companies and more value.
On the other hand, some risks aren’t distributed like that. For example, the risk of societal/geopolitical crisis isn’t per $, it’s per country – the US political system isn’t less prone to collapse because it’s economy is larger. This means, for example, that the risk of the US facing an internal political crisis is (to simplify) not materially different than, say, the UK. If the risk is identical, it makes no sense to bet 65% of our future on a country that could fail just as easily as other countries (again, this is hard to measure, but our error could go both ways). Therefore, a somewhat less efficient distribution from a returns perspective can increase diversification when it comes to other risks.
I think what is important from a passive investment perspective is to be consistent and clear with your strategy. As long as you define the distribution you’re happy with, don’t fiddle with it as markets go up and down – that’s where things start to go wrong.
(As an aside – what we do have a lot of is ex-UK funds, which I find a lot less useful. The UK is a small market so we’re not taking too much of an all-eggs-in-one-basket risk (like when US investors invest heavily in the US) by simply using a weighted global tracker. It only really serves to simplify things if you’re going to tilt in favour of the UK, which course feels like a bad idea for other reasons)
Excellent article. Thanks @TI.
The arithmetic of to loss to gain favours smaller adjustments.
Take a toy example:
Starting value= 1, all in shares.
In scenario A shares double.
In scenario B shares halve.
If you go to cash, and A happens, then you miss gains of 1 (2-1).
But, if A happens, then you only avoid losing 0.5.
So, the ratio is 2:1 against going from 100% shares to cash if both scenarios are equiprobable.
If, however, you decide to move 20% from shares into long duration bonds (i.e. from 100/0 to a 80/20 shares/bonds mix) and, say (for the sake of illustration only), such bonds show a -0.5 (i.e an inverse/negative) correlation to equites then:
– In Scenario A you go from 0.8 to 1.6 value in equities and bonds fall 0.2 to 0.15. You end up with 1.75, not far off of the 2 which you’d have ended up with if you’d kept at a 100% equities.
– In Scenario B you go 0.8 to 0.4 value in equities, but bonds go 0.2 to 0.25, leaving you with 0.65 overall.
So, overall, at the risk of losing 0.35 in Scenario B (1-0.65), you can gain an extra 0.75 in Scenario A (1.75-1); which is a 2.14:1 ratio (i.e. 0.75÷0.35) in favour of moving from 100/0 to 80/20 in equities/bonds (and only 0.25 less than if you’d stuck with a 100% equities).
Basically, in adjusting asset allocations, less can be more.
IMO, return stacking (i.e. WTEF UCITs ETF in the UK, NTSX ETF in the US) can be a way of achieving this without sacrifing too much expectation return. WTEF is 1.5x a 60/40 SP500 / intermediate duration US Treasuries (comprised of 90% S&P 500 capitalisation weighted physical shares and 60% exposure to intermediate duration US Treasuries with 10% in 6x Treasury bond futures using a bond ladder of different durations).
60% in WTEF, 20% in non-US regions’ shares (a capitalisation weighted mix of European, Asia Pacific ex Japan, Japan and Emerging Markets equity trackers) and 20% in intermediate duration Gilts (conventional and/or index linked) would give you an exposure of:
– 54% to the S&P 500 (compared to 65% in Vanguard’s FTSE All Cap Global Index Fund);
– 36% in intermediate US Treasuries
– 20% in ex-US equities
– 20% in gilts
For a total exposure of 130%, and giving a rebased to 100% allocation of:
– about 42% S&P 500
– about 28% US intermediate treasuries
– about 15% ex-US equities
– about 15% gilts
@TI. When I looked I didn’t see much available in world equal weight funds, though there is an Invesco RAFI fund which charges around 0.4%.
I am trying to derisk and move towards a sustainable yield drawdown type approach and unfortunately things like Life Strategy don’t offer much yield (even an ‘income’ class isn’t much use if subfunds are acc.).
Because of my particular circumstances I am trying to derisk into more bonds which is difficult as it means giving up on growth ( the compensation of less exposure to drawdown somehow doesn’t have enough emotional recompense), bond duration not to be more than about 5 years and lots of short duration index linked, and adding a few side hustles to the equity side (Latin America and Pacific index funds…..surprisingly good yield) and some commodity exposure ( cheers TA) in case inflation gets away from us.
US exceptionalism
Land & resources – continental advantage (friendly neighbours, separated from nearest enemies by oceans), significant natural resources base & energy independence, manufacturer of most things
Human capital – 60% of worlds best universities, global centre of tech innovation, attracts and retains best and brightest
Geopolitics – $ the principle global medium of exchange / reserve currency & store of value. A unipolar financial superpower. Military superiority. Strong influence over world order & supranational organisations
Rules based framework – capitalism and free trade beneficiary, independent institutions, constitutional checks and balances
Culture – capitalist, pro investment and wealth creation, shareholder friendly
The structural advantages support dominant capital markets, lowering the cost of capital, attracting more flows. Ever higher share of index tracking funds feeds the momentum. The loop feeds on itself until something breaks it
What shifts the momentum and who takes the market leadership
Europe with our ageing population, low productivity, less capitalist culture, lack of resources, old world industry weights and an ongoing war on the periphery
China under the CCP
India maybe but a long way to go to create the rules based framework for growth that sustainably correlates with equity returns. Not exactly cheap after the rally either, neither Japan
Wider EM not getting anymore stable
The UK…
US equities highly rated for most of the past 15 years. Why mean reversion now. How to weight the risk of being long and wrong vs the risk of being underweight and wrong
Grantham / GMO’s flagship benchmark free allocation fund annualised 3.07% in the last 10 years so a real return of zero over a decade
With a sub 15 VIX and call put skew at a record I wonder about hedging with puts as a means to mitigate the downside but struggle with it philosophically vs reinvesting all cashflows
Erratum (and breaking my rule to only comment once per article): it should be 1.7 v 0.65 and 0.35 v 0.7; not 1.75 v 0.65 and 0.35 v 0.75 (with perfect symmetrical -0.5 correlation).
So, the difference in outturns between scenarios A and B of a small change (100 shares going to 80 shares and 20 bonds) v a large one (100 shares to all in cash) is actually 2:1 in favour of the small change v 2:1 against the large (and not 2.14:1 as stated).
In reality, it would be surprising for bonds to halve if equities doubled, but plausible for bonds to go up 25% if equities fell 50%.
So, by chance, the 2.14:1 ratio in favour of a small asset allocation change, v 2:1 against making a large one, probably is closer to IRL.
Also, small changes make more sense simply because no one knows anything for sure about future prices. Only the other day I came across a 2017 Monevator weekend reading link to a fund manager confidently saying that the equity market was in a bubble. The fund manager in question? Neil Woodford.
We miners are simply minded passive types, we’ll stick to the plan and heed what my grandma used to say “make hay whilst the sun shines”
We are interpreting that as keep the eq:bonds/cash ratios in check with
rebalances and don’t get greedy.
For me, I see the primary risk to be that the US market returns are just really poor for the next 10 years, whereas if the US market crashes then everywhere crashes. So while I don’t feel a need to reduce the overall weighting to the US market (it is after all the most liquid and dynamic stock market globally with earnings sourced globally), i do think there is merit in moving from a market cap weighting for the S&P to an equal weighting index. Only in the last few years with the FAANG then Mag 7 domination have the market cap and equal cap weighted indexes diverged, so it seems reasonable to expect them to reconverge at some point. You’d think. Quite how to implement that strategy when you have a single global market cap weighted equity fund is a different matter though….
Timely article, thanks TI! As many pointed out above, in the absence of an ex-US fund I’ve compensated the Developed World tracker with smaller allocations to Europe, Japan, Pacific ex-Japan, and Emerging markets to get the US allocation of 45%. Could be simpler, but is doable.
Great article. Unlike most others here, I have moved some funds (30%) of my ISA to a Money market fund. I had been considering this anyway as I anticipate I may need a good dollop of cash in a year or so and my ISA was heavily tech and US focused and the index is high. Sometimes it is necessary to take some money off the table. I shall try not to look at the S&P for the next year (ha!). My Sipp remains unaltered as I hope it is a long term investment (I am retired).
What I do with my money is assess the risk. These articles are nicely balanced to pick out the opportunities and threats with enough caveats to only shout “that’s market timing” for giggles.
I have parked these reflections in my subconscious for the next time I can be arsed to tinker with my strategy.
FWIW I think AI is still in its infancy so a portfolio positioned to take advantage of that might be a good bet. The key word there is “bet” and I try not to speculate too hard because of the nosebleeds. Feeling like I am informed of risk is enough, especially the risk that no one knows for sure what’s going to happen.
Unfortunately, I’ve been taking most of these approaches for the last eight years or so, and watched the US tech giants climb higher and higher. Thank you for at least reassuring me that I’m not completely deluded to think the global tracker is a bit unbalanced. However, I have upped my US weighting over time to keep somewhat in line with the rest of the world! I’ve come close to switching to a global tracker a few times, not least because the lack of an ex-US fund means my portfolio is more complex than I’d like.
@Ian — Thanks for sharing, and yes it can be lonely going against the crowd. (And expensive, at least in terms of opportunity cost). I’ve been in-part a growth/tech investor for most of the past 15 years, so dialling down this exposure in my own portfolio more recently hasn’t been easy I concede, though perhaps not too expensive so far.
However I would stress ‘dial down’ rather than ‘avoid’. I still have plenty of tech exposure and a fair bit of US exposure, though far below benchmark now.
As always I think going all-in/all-out something is a very risky call when it comes to broad markets (versus individual stocks or similar). My knowledge is far from perfect, and my judgement is even more fallible. No worries, everyone’s is, but it’s a reminder not to be absolutist IMHO. It’s also hard setting one’s face against momentum from a proven return premiums point of view!
Hence my suggestion in the post of targeting US exposure at 50% — down from 65% but not to 25% let alone 0%. 🙂
Just came across an article from last week by passive investing guru Larry Swedroe on high US valuations over at Kitces.
FWIW Swedroe writes in the exec summary:
But there’s a *lot* more in the full article:
https://www.kitces.com/blog/us-equity-valuations-investment-cape-10-diversification-stocks-sp-500/
A new ETF …
https://etf.dws.com/en-gb/IE0006WW1TQ4-msci-world-ex-usa-ucits-etf-1c/
@Kwaker — Nice spot and how timely!
I could only access the fact page by saying I was an intermediary. Perhaps platforms are going to restrict it to somehow to professional investors/advisers? Hopefully not (that really would be barmy) and it’s just because it’s new.
EXUS (MSCI world ex-USA) is now available to retail investors on AJB. It’s not currently available on ii or Fidelity. I haven’t checked other platforms.
A reminder, if any were needed, that the only constancy is change.
From this week’s IC: 1949-59 Japanese equities return an astounding 1,500% (albeit off of a very low, war devastated base). Nonetheless, bar the oil shock in the 1970s, they contine rising for another 30 years.
By 1989 Japan appears unassailable, with a 45% share of global equity market cap, as compared to just 29% for the US.
Fast forward to now, and despite Japanese equities finally regaining their prior nominal all time high from 35 years ago, the 60% US share of global equities cap is now 10 times the Japanese figure (of just over 5.5% of the global equity MSCI benchmark in 2022).
Re: #8 and #12 above, and observation in @TI’s piece that, “You could track an equally-weighted index, for instance, instead of a market cap-weighted one”:
this 2018 article on portfolio construction/diversification somewhat pours cold water on equal weight being superior than market cap weight:
https://qoppac.blogspot.com/2018/11/is-maths-in-portfolio-construction-bad.html
@Delta Hedge — Well it depends what you want your equal-weighted index tracking to achieve.
It wasn’t mentioned here as a superior form of index tracking, in particular. It was mentioned as a viable way of not being so exposed to 5-10 extremely large companies that seem to be on a very extended run (amazing businesses though they are) if one is minded to do that.
Equal weight definitely avoids risk of over concentration within indices (at the risk of over dispersion). It also is a, if not the, logical choice if/when uncertainty about the path of future returns, volatility & skew is of paramount concern, & if confidence in the past as a guide is weak.
I’m finding it v. difficult to guess whether (or not) to actually take any action over the Mag 7 hitting 30% of the S&P 500 cap, and the S&P 500 hitting (depending on the Dev. World tracker methodology in question) a ~60% to ~70% share.
I suspect that Lars would say do nothing. Philosophically that would be the pure passive approach.
On the one hand, you have this: US Stock Market Cap as % of GDP:
1984: 42%
1994: 63%
2004: 93%
2014: 114%
2024: 187%
On the other hand, the combined revenue of just Amazon, Apple, Google/Alphabet & Microsoft hit $1.53 trillion over last 12 months – larger than the GDP of all but 15 countries.
It’s v. unclear whether & to what extent to be concerned. As always, time will tell.
More context from JPM just in on mega cap US tech outperform: “The good: We’ve reached the 30th anniversary of tech sector profitability crushing other sectors. As things stand now, tech and interactive media free cash flow margins are 3x higher than the rest of the market. Since 1990, large cap US tech stocks outperformed the MSCI World Equity Index by 8,000% to 1,000%. Also good: unlike in 2020/2021, there’s less of a spike in the market cap of unprofitable tech companies (the YUCs).”
The bad is that, even on a forward earnings estimate basis, their valuation is back to 2021 levels.
Interestingly perhaps, on data that I think goes back to 1990, Equal Weight S&P 500 shows an outperformance in 53% of periods and market cap weighted S&P 500 in 47%, so very close, with average P/Es of 15.5x v 16.2x respectively. However, currently the P/E difference is 17x v 21x.
Moreover, since 1996 the top 10 stocks in the S&P 500 have had average forward P/E ratios of 20.3x compared to 15.7x for the remaining 490, but currently the difference is 28.4x v 18.3x.
Always worth remembering that no one knows anything for sure about what valuations truly mean for the future path of returns, and which metrics are relevant (and which are not) to that future.
Inverting here and asking instead what evidence points away from excessive richness in US stock prices:
Paulsen Perspectives: on Market-cap vs. equal-weight: “The SP 500 MC index has outpaced the EW SP Index by quite a margin in recent years, but this chart suggest it could surprise most by continuing to outpace for some time and by much more.” Chart@:
https://x.com/jimwpaulsen/status/1804120013810417861
Thoughts on CAPE etc @:
https://open.substack.com/pub/paulsenperspectives/p/a-different-view-of-valuation
Sam Roe via UBS: “P/Es today are a full standard deviation lower than in the late 90s. On a FCF basis, the S&P 500 is 2 standard deviations cheaper.” Chart@:
https://x.com/SamRo/status/1804170533241512343
The latest on US stocks v the rest and US stocks v other assets’ valuation, from Top Down Charts / Callum Thomas:
https://open.substack.com/pub/topdowncharts/p/12-charts-to-watch-in-2024-q2-update
4 things stand out:
1). The risk of deflation, notwithstanding a residual risk of reflation / ‘higher for longer’. A long duration US Treasuries’ (UST) ETF could be a way to deal with the former, and a Broad Commodities ETF with the latter.
2). UST v SPY ‘Valuation v History’ chart (1983 to date): UST looks a ‘bargain’ and SPY not, relatively speaking. Buying a bargain and selling expensive often doesn’t work though; so perhaps one way to possibly play this one might be to – in effect – take both sides of the bet with a returned stacked product like WTEF ETF, which is 1.5 x a 60/40 (i.e. a 90/60) SPY/UST, rather than just selling SPY to buy UST.
3). US Tech Stock Valuations chart (1984 to date) with equal weighted composite Z scores for CAPE (‘PE10’), Price/Book, P/Div, EV/EBITDA and P/Cash Flow: the slope is not yet as parabolic as it was in 1998-99, but it is steepening. The Z scores are shown, as Sam Ro noted in the link in my last post, as being a good StdDv below the crazy 1999/2000 peak, but this doesn’t mean a blowout will or won’t occur – less still tell us when and how, if it does.
4). Global ex-US Small Value v US Large Growth chart (1995 to date): what a stonking difference over time. Former is now at around a fifth of the relative price (ratio) of latter as compared to 1995, 2007 and 2009, and is equally relatively cheap as it was in the crazy times of 1999. Extraordinary. I’m overweight both ex US Developed and Emerging Market Small Cap Value (‘SCV’) in consequence (as EM is now relatively very cheap indeed compared to history and to DM generally and the SPY specifically). I wonder, therefore, if I should be still more overweight ex US SCV. I’ve kept direct SPY to 50% and full look through US stock exposure to 56% so far. A tilt away from the US rather than something more radical.
@Delta Hedge — Thanks for the updates. I continue to soldier on with I’d estimate about 35-45% US exposure in my equities. (I’m being imprecise because a bunch of it is on a ‘look through’ basis via global / tech trusts and similar.) The sledding is not easy in the face of such a headwind, but I do rightly or wrongly feel good about being less exposed to nVidia when it was at $3trillion for three seconds.
Macron hasn’t helped things though, with some European quality stocks I hold selling off again with his snap election…
@TI – regret minimisation’s a plan, but with losses 2-3x as painful as gains are satisfying, my best guess is that an ability to take on some pain of being ‘wrong’ in the here and now (i e. overweight ex-US stocks and commodities) could in the future be asymmetrical rewarded.
The one thing which I’m not doing though is taking any actions based on predictions for index levels in the near term (i.e. SPX Dec. 2024 targets now at from 4,200, from JPM, to at 6,300, from GS) .
That game scared me out of equities for a while, at just the time that I should have been doubling down following your prescient March 2009 shares on sale piece.
Case in point: Dec. 2008 year end targets for 2009 for the FTSE 100 ranged from IFA Alan Steel’s 5,600 call to Sandy Chen of Panmure Gordon’s 3,500 – in other words, literally useless.
Better, IMO, to think in broad, long holding period asset allocation terms.
What’s the likelihood for the primary asset allocation trend over the rest of my life?
Is it more or less likely to be a rising rates, multiple compression, higher inflation scenario, like the mid-sixties through to 1981, than it is a falling rates/inflation and rising multiples (and earnings) scenario, like 1982 to 2021 (albeit via a valuation bubble in 1995-99 and global economic stroke in 2008-09)?
The effect of the last two primary trend regime changes are seen strikingly in the different ‘behaviours’ of the median CAPE for SPX over different timescales, namely:
– The median CAPE ratio was 15.04 times earnings from 1871-1980.
– The long-term median CAPE is 16.52 times earnings from 1871-Present (all years).
– The median CAPE is now at 23.70 times earnings from 1980 to the present.
Arguably, the shift higher in median SPX CAPE was likely a function (to a significant but debatable extent) of falling economic growth; and a lower discount rate being applied to projected future earnings as a consequence of the lower for longer rates regime of deflationary pressure (with China etc joining the world economy).