The case that looks broken
For the last fifteen years, US stocks have crushed international stocks. The S&P 500 has returned roughly 14% annualized since 2010, while the MSCI EAFE index of developed international markets returned about 6%. An investor who went all-in on US stocks looks like a genius. An investor who diversified globally looks like they left money on the table.
But this outperformance has a specific cause, and it may not last. The outperformance of US stocks since 2010 is almost entirely explained by valuation expansion and a strengthening dollar, not by superior earnings growth. US companies have not grown their profits faster than international companies. They have simply become more expensive relative to those profits. The US trades at roughly 22 times forward earnings today. Developed international markets trade at about 14 times. Emerging markets trade at roughly 11 times. That gap is historically extreme.
The data on inv1000.com
Our comparison tool shows that the gap between US and international returns has been unusually wide in recent years. But it has not always been this way. From 2000 to 2010, international stocks outperformed US stocks by a wide margin. From 2002 to 2007, emerging markets returned over 30% annually while the US returned about 8%. The pendulum swings, and it swings hard.
The argument for international diversification is not that it will outperform every year. It is that no one knows which market will outperform next. The Japanese market was the best in the world in the 1980s and the worst in the 1990s. Emerging markets were unstoppable in the 2000s and uninvestable in the 2010s. The US has been dominant since 2010. History suggests these cycles persist, and the odds of the current leader staying ahead for another decade are lower than the recency bias in our brains wants to believe.
What to do
You do not need to bet heavily on international stocks. But a 20% to 40% allocation to developed and emerging markets provides genuine diversification at a time when US stocks look historically expensive. If US outperformance continues, the 60% to 80% you keep in US stocks will more than carry the portfolio. If the pendulum swings back, the international allocation will cushion the blow. That is the point of diversification: not to maximize returns in the best case, but to survive the cases you did not see coming.