It should probably be obvious, but when inflation has been high in the United States in the past, indices which are outside of the United States have tended to outperform. There is a phenomenon in financial behavior, however, known as ‘home bias’. From Investopedia:
“Home bias is the tendency for investors to invest the majority of their portfolio in domestic equities, ignoring the benefits of diversifying into foreign equities. This bias was originally believed to have arisen as a result of the extra difficulties associated with investing in foreign equities, such as legal restrictions and additional transaction costs. Other investors may simply exhibit home bias due to a preference for investing in what they are already familiar with rather than moving into the unknown.”
We’ve observed that home bias is so strong that often in conversations about hedging against inflation, even with financial professionals, non-U.S. based assets are not even considered. Which (United States) stocks to buy; which (United States) bonds to buy; which commodities (on United States exchanges) to buy; which (United States) real estate to buy — these are the conversations we hear. Even the highly complex and volatile class of cryptocurrencies come up as options more often than foreign investments, which doesn’t make a lot of sense to us, considering that high United States inflation is just another way of saying a high rate of loss of dollar purchasing power. So, it’s at least plausible that during such periods, getting assets out of the dollar might help.
It looks, in this analysis we’ve done, as if it generally has in the past:
The height of the purple bars represents the average return for each index during past quarters where inflation was in the top fifth (according to the available data at the time of this analysis). According to this, during such periods of elevated inflation, Emerging Markets (EM) performed best. Global (excluding United States) was next, Developed Markets (excluding United States) after those two, and a Large Cap United States index last in this set. It should be said that some domestic equity sizes and styles do better than Large Cap, but none of those we looked at in the piece on United States equity beat the EM returns as shown above, and most failed to beat Global excluding United States.
So, there appears to have been a tendency towards better performance outside the United States when inflation was high inside the United States, which we believe makes sense. But remember, these returns are averages, and a high average return doesn’t mean that every individual country inside the index had a high return, so there is a case for added selectivity and sensible diversification to be added to the strategy.
How did these global index options do when United States inflation was low? Not so well according to our analysis.
(Source: Bloomberg, St. Louis Federal Reserve, Bowyer Research)
All of the indices shown, on average, delivered negative returns during low inflation periods (the gray bars above). We were a bit surprised about how well EM tended to hold up during such periods. This may have something to do with the well-observed pattern in which EM tends to outperform the rest of the globe in general.
Investing overseas is scary to some people. Inflation is also scary. But wise investors who were frightened by inflation may have been well-served in the past to overcome their fear of foreign markets.
The opinions expressed herein are those of Vident Financial at the time of publication and are subject to change. This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the information described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. Recipients should not rely on this material in making any future investment decision.
Investors cannot invest directly in an index. Indexes are not managed and do not reflect management fees and transaction costs that are associated with some investments. Past performance does not guarantee future results.
