August 7, 2019

Where Home Bias and Recency Bias Collide: Choosing Between U.S. and International Stocks

With the U.S. stock market reaching all-time highs, this is a good time for investors to check their global stock portfolios for evidence of home bias and recency bias — two of the most widespread and potentially dangerous investment behavioral biases.

What happens when circumstances cause these two biases to converge and reinforce each other? We may be about to find out.

In recent years, home bias and recency bias have combined forces to test the discipline of U.S.-domiciled investors.  The recent exceptional successes of U.S.-based companies such as Netflix (+484%), Amazon (+483%), and Facebook (+187%), over the past five years ending 6/30/19, along with the outstanding broader U.S. market gains over the past five years, have given rise to a dangerously alluring train of thought:  with U.S. stocks performing so well, why would anyone invest overseas?

In the graphic below, we can see how U.S. stocks have been leading the pack in recent years.

Unfortunately for today’s investor, the U.S. stock market’s extended rally has led to a situation where the United States, a country that represents 4.5% of the world population1 and 15% of the world’s economy,2 now represents 55% of the entire world’s stock market capitalization.3

With the New York Federal Reserve projecting a 33% chance of a U.S. recession in the next 12 months, and U.S. stock valuations at a 27% premium to non-U.S. stocks, we believe that this is a good time for U.S.-based investors to check their portfolios for recency and home biases.

As a point of reference, many investors use a global stock index such as the MSCI ACWI Index as a template for designing a “geographically neutral” portfolio. The chart above shows the current geographical allocation of the MSCI ACWI Index, in which the U.S. stock market accounts for 55% of the Index, with non-U.S. markets making up the remaining 45% of the Index.

Despite the fact that in the MSCI chart the U.S. stock market visually resembles a “Pac Man” that is about to consume the rest of the world, we think the U.S. share of the global stock market is likely to grow smaller over the next decade due to high U.S. stock market valuations and low U.S. growth projections relative to the global average.

Such changes in leadership are normal.  Looking back over the past few decades, we can see that stock market leadership has periodically cycled back and forth between U.S. and international markets, with the most notable period of U.S. outperformance having occurred in the 1990s, culminating in the dot-com bubble.

While we can’t predict exactly when the current period of U.S. outperformance will end, we believe it would be unwise for an investor to wait for a disruptive market event to start thinking about home bias and recency bias.  Rather, the time to think about these biases is now.


1 Trading Economics, 2019
2 International Monetary Fund, 2018
3 MSCI ACWI Index, June 2019