A few days ago, someone challenged me with this question: “Following the market’s most recent banner year, should we just sell everything and get out?” The question is understandable. Since hitting bottom in 2009, the U.S. stock market has quadrupled in value, including a 30% gain in just the past year.
Individual investors aren’t alone in asking this question. A few weeks back, at an industry conference, a fellow named James Montier delivered a presentation in which he compared the U.S. stock market to “Wile E. Coyote—the hapless adversary of Roadrunner—having run off the edge of a cliff only to realise the ground is no longer below his feet.”
Montier is no armchair critic. A Senior Asset Allocation Strategist at the investment firm GMO, his presentation was thoughtful and well argued. His message: Get out of domestic stocks, where valuations are “in the realm of disbelief” and move your savings into Emerging Markets stocks and other assets, where prices are much more reasonable. That, he noted, is exactly what his firm has done, owning “essentially zero” domestic stocks. Montier supported this argument with detailed facts and figures.
As an individual investor, what should you make of these arguments? Is now the time to sell out of U.S. stocks? I have four concerns with this idea:
1. Yes, the market might fall—but it might go higher first. You don’t have to look too far back into history to see an example of this. Suppose, for example, that it were the beginning of 2017, and you felt that the market was pricey. At that point, it would have been a reasonable expectation to predict a downturn. After all, the market had already tripled over the preceding eight years. So suppose you sold all your stocks at the beginning of 2017. Well, you would have been proved right: The market did subsequently fall. In 2018 the market hit several potholes and was negative for the year. But here’s the problem: When the market dropped in 2018, it fell to levels that were still higher than the level at the beginning of 2017. Result: Even if you had correctly predicted a dip in the stock market, you still would have been worse off. The lesson: Timing is everything, and it’s very hard to know when something is going to happen. Yes, history can serve as a guide, but not a crystal ball.
2. The second concern is related to the first: What action would you take after selling? Would you plan to buy back in? If so, at what level? And what if you got a repeat of 2017, in which the market did subsequently decline, but not to a level any lower than where you had sold? Then you might find yourself stuck in cash while the market continued to march higher.
3. If you sell assets out of your taxable account, what would be the tax impact?
4. Valuation is not a science. There’s no question that valuations on domestic stocks are higher than those in other parts of the world. But that doesn’t mean there’s a mathematical certainty that they will fall or that valuations in other parts of the world will rise. The reality is that the U.S. is home to a larger number of bigger, more innovative and more profitable companies than anywhere else. Consider just the top five companies by market value: Microsoft, Apple, Google, Amazon and Facebook. You’d be hard pressed to find equivalents of these companies anywhere else in the world, let alone all together in one country. If you look around the world at other major economies, I think you’ll find good reasons for this. In Europe, cultural norms discourage entrepreneurship. In Japan, they are contending with a shrinking population. And in China, the government’s posture makes it hard for too much creativity and innovation to flourish. In other words, I don’t see it as an accident that the United States tends to breed more innovation than anywhere else. For that reason, maybe there is good reason why domestic stocks carry higher valuations—and why that might continue in the future. Is this guaranteed? Hardly, but my point is that valuation is not a science.
Could things turn out the way Montier is predicting? Certainly. But they might not. What’s important to understand is this: Montier’s argument is perfectly logical, but you could just as easily construct an argument to support the exact opposite view. That being the case, the best approach, in my opinion, is the simplest: Structure a portfolio that is sensibly diversified among global markets in a way that acknowledges these uncertainties. Then leave it alone. Unless your financial circumstances change, don’t tinker.
