Americans tend to be Ameri-centric in their investing. By that I mean that we tend to invest more in American stocks and bonds and less in international securities than models predict we should. Our domestic markets are mature compared to many foreign ones. While maturity can mean stability, it generally comes with slower growth rates. Emerging market economies, in contrast, exhibit higher growth rates. To maximize expected returns and benefit from geographic diversification in our investment portfolios it makes sense to invest outside the USA.
Some investors push back against such suggestions, pointing to favorable returns realized in American markets since the 1950s. Indeed, many financial planning strategies are based on the assumption that American stock markets will continue to perform as they have over the past seventy years, yielding on average around 10% per year. In accepting these assumptions, however, advisors and investors may be committing the most basic error in the risk management book—assuming the past predicts the future. There’s no compelling theory or evidence that guarantees this level of average returns in American markets. If anything, one can tell a very different story with far less favorable predictions.
The short version of the story is that after the Second World War every other country in the world that mattered to the global economy had been reduced to rubble. The United Kingdom—ostensibly the military winner in Europe—had been drained over six years of all-out war. The country was on the verge of bankruptcy and had already, or soon would, lose many of its colonies. The war effort had been so all-consuming that for several years after the war ended it was necessary to impose nationwide rationing. The rest of Europe, including France, Italy and other major economies, had been severely mauled by the war. Germany and Russia were devastated. In Asia, similar devastation had been visited upon the Japanese home islands. China, Korea, and other Japanese conquests had also suffered terribly.
Only one country escaped unscathed—the United States of America had not only avoided devastation. It had developed a rich portfolio of new technologies as part of the war effort, in electronics, aviation, machinery, manufacturing, food production, transportation, etc. This meant that the USA had a huge head start on everyone else. Its flexible and bold (albeit imperfect) capitalist system was able to quickly exploit this advantage. The rest of the world had to trade with the USA because for many products, it was the only game in town. Over the next half century this advantage allowed American companies to grow dramatically, giving them a nearly unshakeable global footprint. American companies had unfettered access to just about every market that mattered globally (with the notable exception of those behind the Iron Curtain). Under such favorable circumstances it’s easy to see how American companies and their publicly traded stocks performed very well.
Global competition is tougher now than ever before in modern history. China, Brazil, India, and Russia are huge countries with low-wage workforces and increasingly sophisticated engineering and high-tech capabilities. Their ability to copy existing products and to innovate on their own makes it possible for them to undermine or undercut American products and services. It doesn’t matter whether we view some of these tactics as unethical or underhanded. The point is that there isn’t much we can do about them. We also must compete with all the other industrialized nations—Germany, France, the United Kingdom, Canada, Australia, Italy, South Korea, among others—and every other developing nation. There’s some evidence that we’re losing the renewable energy, robotics, artificial intelligence, and 5G races, ceding leadership, jobs, and prosperity to other countries that have committed to these technologies faster or more effectively than us.
Furthermore, our national debt has risen to astronomical levels and our Social Security system is on the verge of insolvency.
Where does all this leave us? It leaves us vulnerable to being wrong as we continue to assume our stock markets will yield 10% annual returns.
I’m not saying all this to cause panic. The bottom line is that we don’t know how markets will perform in the next twenty, thirty, and forty years. But we should not blindly assume that favorable past performance somehow guarantees our future.