The S&P 500 advanced 27% over the past year due to stronger-than-expected economic growth in the U.S. and hopes that the Federal Reserve will soon pivot to interest rate cuts. Enthusiasm about artificial intelligence has also pushed the U.S. stock market higher.
However, some analysts are forecasting an S&P 500 correction in 2024, meaning they expect the index to fall at least 10% from its high. JPMorgan Chase has a year-end target of 4,200 on the index, implying a downside of 17% from its current level of 5,070, while Morgan Stanley's target of 4,500 implies a downside of 11%.
To be clear, not every Wall Street analyst predicts the index will decline. For instance, Goldman Sachs recently raised its year-end target to 5,200, which implies about 3% upside. However, some analysts are pessimistic because the S&P 500 now trades at 20.4 times forward earnings, which is well above its 10-year average of 17.7.
Morgan Stanley's chief investment officer, Lisa Shalett, recently wrote, "Valuations of non-U.S. equities versus the S&P 500 are at a 20-year low." That makes this an excellent time to diversify your portfolio with an exchange-traded fund (ETF) that focuses on non-U.S. stocks.
The Vanguard Total International Stock ETF
The Vanguard Total International Stock ETF (VXUS 0.81%) holds shares of more than 8,500 foreign companies. It includes value and growth stocks from every developed market and emerging market around the world, excluding the U.S.
The fund is most heavily weighted toward European equities (40.6%), followed by Asia-Pacific equities (27.1%), and emerging market equities (24.7%). North American equities (7.1%) and Middle Eastern equities (0.4%) make up the remainder. The ETF's 10 largest holdings are:
- Taiwan Semiconductor Manufacturing: 1.6%
- Novo Nordisk: 1.2%
- ASML: 1.2%
- Nestlé: 1%
- Samsung: 0.9%
- Toyota Motor: 0.8%
- Tencent Holdings: 0.7%
- Novartis: 0.7%
- LVMH Moët Hennessy Louis Vuitton: 0.7%
- Shell: 0.7%
The Vanguard Total International Stock ETF returned a total of 52% during the last decade, with its growth compounding at an average of 4.3% annually. That dramatically underperformed the S&P 500, which returned 230% for a compound annual growth rate of 12.7%. However, with the exception of cryptocurrency, no major asset class beat the S&P 500 over the last 10 years.
I've previously suggested that investors avoid mutual funds and ETFs that have consistently underperformed that benchmark index over long periods. An S&P 500 index fund is such a cheap and easy investment option that it rarely makes sense to settle for anything else. But I would make an exception in this case for two reasons.
First, a recent study found that portfolios that blend international and domestic stocks tend to outperform portfolios limited to domestic stocks during the course of a normal lifetime. In fact, the average return in blended-equity portfolios beat the average return in domestic-equity portfolios across three metrics: wealth at retirement, income during retirement, and wealth at death.
Second, the current elevated valuation of the S&P 500 makes a compelling case for investing some money in international stocks right now. The Vanguard Total International Stock ETF is a reasonable, cost-effective way to achieve that goal. Its expense ratio is just 0.08%, meaning the annual fee on a $10,000 portfolio would be $8.
How investors should think about asset allocation
History suggests that investors should keep most of their money in U.S. stocks. The S&P 500 returned an average of 10.3% annually over the last 30 years. It also outperformed almost every major asset class over the last five years, 10 years, and 20 years. That includes equities in Europe, Asia, and emerging markets, as well as international bonds and precious metals.
However, the S&P 500 currently trades at a premium to its average forward earnings multiple for the last decade. That suggests that many U.S. stocks may be overvalued, and a broad shift to correct that could drag the S&P 500 down sharply. Regardless, from their current valuations, the Vanguard International Stock ETF has a reasonable shot of outperforming an S&P 500 index fund over the next three to five years.
