Investors in U.S. stocks have enjoyed an extraordinary bull market for much of the past 15 years. As the chart below illustrates, U.S. equities (S&P 500) have been the best-performing asset class since 2013, consistently outpacing Canadian stocks (S&P/TSX), international developed-market equities (MSCI EAFE), and Canadian long-term bonds.
Between 2000 and 2012, however, the U.S. market never claimed the top spot. This was partly owing to the fact that the returns in the chart are measured in Canadian dollars.
The chart also highlights the persistent underperformance of international stocks. Over the past 25 years, even Canadian long-term bonds have held the top spot more often than the MSCI EAFE index. It is noteworthy that when bonds were the top performer, stocks were not even close. This helps to explain why professional money managers invest a portion of most portfolios in bonds.
While U.S. stocks have been dominant, their outperformance has come with rising risks. A significant portion of the gains has been driven by expanding price-to-earnings (P/E) ratios, making valuations increasingly stretched. If history is any guide, a reversion to the mean could hit U.S. stocks harder than other asset classes.
So what’s an investor to do? Diversification – across both asset classes and geographies – is key. Relying too heavily on one market, even a strong one, adds risk.
A well-diversified portfolio helps capture opportunities elsewhere while reducing exposure to a potential U.S. downturn. That’s something anyone looking to build a well-funded retirement portfolio should keep in mind.
Frederick Vettese is former chief actuary of Morneau Shepell and author of the PERC retirement calculator (perc-pro.ca)
