Business Economics Investing

Home Country Bias Alert

Most investors’ equity asset allocations tend to overweight their home countries, which can be very inefficient from a return standpoint. It doesn’t appear to be a problem when their home countries are rising but can be especially painful when markets reverse course.

Developed market stocks and their investors have had a good run this cycle while emerging market stocks and their investors have had a bumpy run although 2017 was a good year. The difference in performance is likely the result of several factors, but the chart below from Goldman, courtesy of the WSJ’s Daily Shot, paints a divergent economic fundamental picture, which likely has at least something to do with the return differential between developed and emerging markets this cycle.

Interestingly, emerging markets (ex. China) appear to be early cycle while developed markets appear to be entering or are already in the late stage of the business cycle. Valuations certainly reflect this fact as most developed markets trade at elevated levels and several emerging markets trade at substantially lower levels. Of course, some of the valuation discrepancy has to do with the riskier nature of emerging markets. However, lower valuations coupled with “early cycle” economic fundamentals could be a good combination for future emerging market outperformance.

Developed market-based investors beware.