Should you look to invest abroad for lower risk opportunities?

The S&P 500 price-to-earnings ratio, for an estimated 12 month earning, was 22.18 as of the end of June – the highest it’s been in almost 20 years. This, along with some other measurement techniques, tells us that American companies are profoundly overvalued right now.

Many of us think of the risk/reward trade off as relatively universal across markets, but this is a great reminder that this isn’t the case — American exchanges right now are offering little reward given their risk.

An Untrustworthy Bull 

We can see the risk reflected in the current volatility that COVID-19 has caused. It’s been somewhat unnerving to see a bull market in a time where many service businesses have been closed entirely, offices have to work from home and highstreets deserted – not to mention the race riots, political scandals and a US recession.

Something is clearly off here. More than 3 out of 4 fund managers deem the market to be overpriced according to a Bank of America survey, with more than half claiming that the Bull market since the March crash is in fact merely a bear market rally.

These survey results are something we haven’t seen since 1998. Only 18% of the fund managers believe that there’s going to be a V-shaped recovery in the economy, with W or V being more likely.

The March crash was born out of COVID-19, there’s no doubt, as well as the Russia-OPEC oil price war. But with the consensus being that there may be a second wave, and that the US has no real plan to tackle it, it’s difficult to imagine a V-shaped US recovery from the recession it’s in.

Active investing in the US

It’s difficult to believe that the market is more valuable now than it was at Christmas last year, yet this is what prices tell us. Long-term, passive investors will claim they’ll ride out whatever crash is impending, and continue investing whilst the market is deeply discounted. Whilst active traders will claim there’s either still some growth left to be gained, or the elevator it takes down can be captured if timed right.

The issue is that investors rely too heavily on the US market for investing. The USD is weakening, the annual rate of interest is 0%, and markets are more volatile and overpriced than they’ve been in a long time.

2020 is the year for market records it seems, and in March the 10-year Treasury fell to a new all-time low. It slumped to 0.318% as investors opted for stocks instead of the safety of bonds. This could somewhat be explained by the huge spike in retail investors in the US during the pandemic. 

More and more retail investors have joined the market due to broker apps becoming free and more accessible, along with the extended leisure time and high market volatility. In a self-perpetuating nightmare, volatility has been like moths to a flame, which only furthers the overpricing of household-name stocks. 

The US stock market has been proved to poorly reflect what’s actually going on in the economy, but really, the US bond market has continuously given us warning signs about what’s going on. It wasn’t long after this record low that the US officially entered a recession.

The case for looking abroad

There are plenty of markets around the world that are not suffering from the same level of volatility and overpricing. There are even countries that are hardly even suffering from COVID-19 uncertainty…

The US 0% interest rate also means that there’s little point saving money here, if you’re looking for low-risk capital gains. You can easily find Canadian saving accounts offer a 2% interest for example, with the country having a prime interest rate that’s positive.

If the weak USD puts you off investing abroad and purchasing another currency, then there’s also markets and countries that still use USD. Admittedly, these aren’t very strong markets, but some are popular for saving money there for tax purposes. Alternatively, finding countries whose currency correlates with the USD will mean that you’ll be less exposed to the USD fluctuations.

Or, you can simply invest in US-based foreign ETFs, so you only deal in USD with your US broker. This may pose some currency risk, but it may be deemed less risky than the US market itself.

If we take Japan as an example. Japanese equities are actually undervalued, according to many experts. Yet, dividends are increasing and there’s room for potential growth in the future. Japan is politically stable, has great corporate governance, and has COVID-19 somewhat underwraps. Japanese have streamlined their companies since the 2008 crisis and are now holding large cash reserves.

Some of the US-based Japanese ETFs are:

  • iShares MSCI Japan ETF
  • WisdomTree Japan Hedged Equity Fund
  • iShares Currency Hedged MSCI Japan ETF
  • JPMorgan BetaBuilders Japan ETF

Final Word

Ultimately, investing abroad can help US investors spread their investment risk among foreign companies and markets, thus improvising diversification. This isn’t 2008 — it’s unlikely that there’s going to be a global existential collapse that questions our capitalist system in the same way. It’s mostly a supply issue, where the US, UK and some other countries’ businesses are struggling to offer their services during a pandemic — as well as apprehensive consumer spending of course.

Government funding is putting the plaster on, but eventually there will be hardship in the US (more so than already). Many countries, particularly in Asia, South America and some parts of Europe, have COVID-19 somewhat under control and markets are stable.

US investors could take advantage of overseas markets that are undervalued, all whilst diversifying their portfolio during what seems to be the most absurd and irrational US market in recent history. 

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