The pandemic taught us many lessons. But none may be more pronounced than how massively interconnected the world is—often in ways that none of us had known before.
Globalization has been a boon for many companies, as it has allowed some to compete in new markets or become specialists in niche areas. Some labor markets have also benefited with more opportunities, while others have been hurt (U.S. manufacturing, for example).
But while benefits abound, there are also some adverse effects from global trade. For example, consider the multitude of supply chain bottlenecks when one country closes its factories due to COVID-19. Or when a significant supplier of global wheat is embroiled in a war. These are glaring examples. However, there are more subtle ones, too, like changes to the work week in France or passing a government subsidy for local industry. These regional shifts may impact the operations of companies in those regions and their trading partners.
So when investing in non-U.S. companies or even in U.S. companies that derive a significant portion of sales from overseas, how can investors weigh geopolitical risks?
There’s a big world out there
Let’s start with a simpler question: Why bother investing beyond the U.S. anyway? It’s hard to put forth a valid argument that investing beyond the U.S. makes sense. But while the U.S. stock market has significantly outperformed developed international and emerging markets since 2008, that hasn’t always been the case. In fact, from 1999 through 2007, emerging markets were the best by a long shot, while the U.S. achieved significantly lower returns.
Source: Bloomberg, UBS. As of Dec. 31, 2021
Another reason is that the world is enormous. The U.S. makes up only about 20% of global GDP but holds up to 60% of the value of all listed securities. The rest come from overseas. But that's not all.
Source: UBS Financial Services. Jan 12, 2022
The U.S. market is largely efficient, making it more difficult for investors to outperform. But the non-U.S. market is not. A lower investing culture internationally can increase the odds of mispriced securities, providing an opportunity to cash in on these inefficiencies.
And finally, the U.S. market tends to be expensive. Currently, it is trading at 22.9x trailing earnings, while the global market is at 12.1x.1
But global investing faces barriers
Finding the world's best companies and buying them in your portfolio seems so straightforward. But of course, it's not that easy for several reasons.
First, there are currency impacts to consider. For example, the U.S. dollar is stronger now than most other currencies. So that means that U.S.-based companies selling their goods overseas are at a disadvantage because their goods appear more expensive than those from local providers. Similarly, sales revenue falls when a U.S. company translates its foreign sales into U.S. dollars.
Second, every region has local laws and customs that may affect business operations. For example, say you have two companies that manufacture pasta. One is in Italy (of course!), and the other is in the U.S. The Italian company may have a higher risk now because of the upheaval following Prime Minister Mario Draghi's resignation. There's a fear that the newly elected government will be anti-EU and try to break from the eurozone, which could pressure local companies financially.
Finally, tensions between countries may unintentionally hurt certain companies or industries. The Russia/Ukraine War is a current example. As fears of an invasion manifested and sanctions followed, investors fled Russian investments. So even if a Russian company was a global leader, its stock was likely hard hit by the war.
So how could investors account for these heightened risks?
No one can predict what will happen with global politics or events
1The S&P 500 is a proxy for the U.S. market and the FTSE All-World ex-U.S. for the global market. 12-month trailing price-to-earnings as of August 31, 2022.
2 jstor.org, Oct. 1997
* This article is not a recommendation to buy or sell any securities. The securities identified and described in this article do not necessarily represent the securities purchased or sold for our funds, and in the aggregate may represent a small percentage of a fund's portfolio. You should not assume that an investment in these securities was or will be profitable, and there is no assurance, as of the date of article, that the securities have been or will be purchased or will remain in a fund's portfolio. A complete list of fund holdings can be found at www.FoolETFs.com.
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