With the rise of the global economy, including international investments in your portfolio has become almost a necessity. Yet just as some are turning to emerging markets as the last refuge of strong economic growth in the world, one longtime stock guru is sounding the alarm that having too much exposure to international stocks could be a big mistake in the years ahead.
Keep it down
Vanguard founder John Bogle has seen a lot of ups and downs in the financial markets, and he's no stranger to fads. From the Nifty 50 stocks of the 1960s to 2008's financial crisis and its aftermath, Bogle's experience lends a long-term perspective to the short-run movements of the markets.
Recently, though, what's raised concerns for Bogle is the emphasis on international investing, especially in the emerging markets. In an interview with Morningstar, Bogle said investors are focusing too much on past returns, which have boosted international stocks well above their flat-lining U.S. counterparts.
Going forward, Bogle expects international and U.S. stocks to perform roughly in sync with each other. But because of unfamiliar risks, including sovereign risk, the cloudy currency picture, and political uncertainties, Bogle recommends steering clear of international stocks entirely if at all possible, and at most setting a 20% maximum allocation to foreign stocks, with no more than a 10% allocation to emerging markets.
Certainly, Bogle isn't alone in his concerns about emerging markets. Both Barton Biggs and Jeremy Grantham believe that emerging markets are entering a bubble stage, although they see ample chances for opportunistic investors to take advantage before counting on the Greater Fool theory to bail them out before prices finally come crashing down.
But Bogle's sentiment is based more on long-term dynamics. A decade ago, emerging markets had very attractive valuations, based on their historical difficulty in getting past problems like high debt loads and lack of financing. Ten years later, emerging markets have posted double-digit annualized returns since 2000, while U.S. stocks remain flat. So it's easy to conclude that the best opportunities to invest internationally are in the past.
Your backdoor to the world
One point that many investors make is that even if you stick with U.S. stocks, you're still heavily exposed to the global economy. Companies with world-renowned brands rely on international markets for vast parts of their revenue. Coca-Cola (NYSE: KO ) earned more than 70% of its revenue outside North America in 2009, while rival PepsiCo (NYSE: PEP ) had international revenue almost equal to its U.S. sales. Yum! Brands (NYSE: YUM ) had a 59% international share of revenue, including more than a third from China alone.
Nor does the trend relate solely to goods. The combination of technology and associated consulting from IBM (NYSE: IBM ) abroad contributes 65% of the company's revenue. Even insurance giant Aflac (NYSE: AFL ) , which is purely a service company, earns almost 80% of its revenue and operating profit from its Japanese business segment.
Of course, that argument runs both ways. Obviously, major exporter Toyota Motor (NYSE: TM ) gets a huge portion of its revenue from North America -- 30% in 2009. America Movil (NYSE: AMX ) does business predominantly in Mexico, but its TracFone offerings in the U.S. account for almost 6% of its revenue. Those figures could well grow as emerging-markets companies gain strength to expand beyond their borders.
Where I think Bogle's argument is weakest is in his assertion that it's the rest of the world that will show the biggest problems going forward. You'll find plenty of signs that the U.S. has "its own kind of idiosyncrasies" that could threaten returns for investors in domestic stocks.
International stocks have definitely been on a strong run. But investors who dismiss them as overvalued do so at their peril. It may well be that their larger returns are completely justified by the changing dynamics of the world economy.
International stocks are here to stay, and ETFs are a great way to play them. Click here to get some international investing ideas in The Motley Fool's free report, 3 ETFs Set to Soar During the Recovery.