Exploring Global Diversification as a Strategic Hedge Against S&P 500

For years, the S&P 500 has reigned supreme, outperforming international stock indices. Yet, with a potential correction looming over the U.S. stock market, Morgan Stanley Wealth Management advises that investing in international stocks might be an effective and low-cost strategy to hedge against such risks.

So far this year, the S&P 500 has seen an impressive 6.4% increase, overshooting global gains. However, the iShares MSCI ACWI ex U.S. ETF, which represents international stocks minus the U.S., trails with a modest 1.7% uptick.

Geographical Diversification for Portfolio Stability

Lisa Shalett, the Chief Investment Officer at Morgan Stanley Wealth Management, sheds light on this scenario, indicating that investor overconfidence in the U.S. market, based on its past performance, might be misplaced. She suggests that, given the attractive valuations and higher dividends of non-U.S. equities, now may be a prime opportunity for investors to balance their heavy U.S. equity positions with investments in regions such as Europe, Japan, and select emerging markets including Brazil, Mexico, and India.

Shalett points to encouraging signs in these foreign markets, such as fiscal reforms and economic stimuli, which could spur profits, especially in the face of favorable conditions such as regaining political stability and shifts in global supply chains.

Valuation Discrepancies as Investment Opportunities

U.S. equities carry high valuations in comparison to their international counterparts. The S&P 500's forward price-to-earnings ratio hovers above 20.4, while the MSCI ACWI ex U.S. stands around 13.5, marking a substantial discount. Additionally, non-U.S. equities are offering dividend yields over 3%, doubling that of the S&P 500. This scenario, as Shalett notes, presents a 20-year low valuation gap and an opportunity for investors.

The dominance of U.S. stocks in global indices is not entirely aligned with economic fundamentals. For example, U.S. stocks comprise over 63% of the MSCI All Country World Index, despite the U.S. holding a smaller percentage of global GDP. With global growth and interest rates expected to align and U.S. monetary policy optimism already reflected in high valuations, Shalett suggests that diversification could guard against potential market adjustments.

Regional Market Highlights

Breaking down regional performance, the iShares Europe ETF has slightly risen by 1.8% this year. In contrast, the iShares MSCI Japan ETF has jumped 7.6%. While some emerging markets like India have seen a healthy 5.6% gain, others like Brazil and Mexico face declines in their respective ETF performances.

Moving back to U.S. markets, a mixed trading picture shows the Dow Jones Industrial Average slightly down by 0.1%, the S&P 500 dropping by 0.2%, and a marginal 0.1% rise in the Nasdaq Composite. The S&P 500's slip comes after reaching a record high the previous Friday.

Given these dynamics, Shalett highlights the importance of diversification not only as a performance strategy but also as a protective measure against potential volatility spurred by geopolitical, political, and debt sustainability concerns in the U.S.

Diversification, Investing, Hedge