I have been expecting foreign stocks to outperform U.S. stocks in recent years, but I’m still waiting, notes Chuck Carlson, dividend reinvestment specialist and editor of DRIP Investor

Covid hit overseas economies especially hard, causing foreign stocks as a group to woefully underperform the rebound that U.S. equities posted in 2021. And I thought 2022 would be the year that foreign stocks would outperform because I thought 2022 would be a “value” year for stocks, and a value tilt would be good news for foreign stocks.

However, what started out as a value year for stocks has turned into a lousy year for all stocks (growth and value), with foreign stocks doing even worse than U.S. stocks year to date.

If foreign stocks underperform U.S. stocks for 2022 overall, it will be the ninth year out of the last ten that foreign stocks have underperformed U.S. stocks.

So, is the set-up finally improving for foreign stocks? The answer is no. Covid continues to be a problem in parts of the world, especially in China. The war in Ukraine has been a destabilizing factor. And the strong U.S. dollar puts added pressure on certain foreign economies that require U.S dollars to repay their debts.

To be sure, valuations on foreign stocks are discounting at least some of these troubles. The P-E ratio on the benchmark MSCI EAFE Index is approximately 12 versus 17 on the S&P 500. And the dividend yield on the MSCI EAFE is over 4% versus 1.7% on the S&P 500. So the valuations and cash flows are enticing.

However, international stocks, as a group, have probably been one of the bigger “value-trap” investments in the last decade, so it is dangerous to say that this time around will be different.

Still, while I don’t think investors should be expanding their overseas exposure, I don’t think they should be abandoning it either. Factors that would provide a boost to foreign stocks would be a resolution to the Ukraine war and some softening in the dollar. Also, a sustained improvement in value stocks would help.

Despite the significant underperformance of international investments for the last several years, I still maintain exposure to international stocks, primarily through my company’s 401(k) plan as well as a few individual international stocks.

Why do I maintain international exposure? I still think the pendulum will swing back at some point in favor of foreign stocks, and I want to have exposure when the swing occurs. Said differently, I believe in “reversion to the mean,” and I can see a time that value will matter again. But I think it is important to moderate your exposure to international stocks.

In a long-term investment program, 10%-15% international exposure, with the bulk in developed countries and a smaller position in emerging markets, is a reasonable target level for a portfolio that is 100% invested in stocks. If you have a balanced portfolio (say, 50% to 60% in stocks), cut that 10%-15% exposure in half.

The most common way to invest overseas is via global mutual funds and exchange-traded funds. With one investment you can diversify your funds across many stocks and countries. Vanguard offers two broadly diversified international funds, the Vanguard International Growth (VWIGX) mutual fund and the Vanguard FTSE Developed Markets (VEA) exchange-traded fund.

For coverage of small and mid-cap international stocks, consider the iShares MSCI International Small-Cap Multifactor (ISCF) exchange-traded fund. And for emerging markets, the Vanguard FTSE Emerging Markets Index (VWO) exchange-traded fund offers a low-cost option.

While using mutual funds and ETFs is certainly the easiest and simplest approach, you will probably have a better chance of beating U.S. stocks by investing in individual international stocks. Because of the breadth of choices across the globe, I think international stocks are probably less efficient and under-researched, which may present opportunities.

Thus, when investing overseas, I prefer a “hybrid” strategy, which considers funds and ETFs along with individual foreign stocks. Think of it as a “hub-and-spoke” approach to international investing. The hub of the portfolio consists of mutual funds and ETFs. The spokes represent individual stocks.

The good news is that it is extremely easy for any U.S. investor to buy individual foreign stocks via American Depositary Receipts. ADRs are securities that trade on U.S. exchanges and represent ownership in shares of foreign companies.

Investors buy and sell ADRs just as they buy and sell U.S. stocks. ADRs are quoted in U.S. dollars and pay dividends in U.S. dollars. And those dividend payments, in many cases, receive the current preferential tax treatment afforded qualified dividends paid by U.S. companies.

Among individual stocks, two that I own and recommend for long-term returns are Novo Nordisk (NVO) and Ryanair Holdings (RYAAY).

Novo Nordisk, based in Denmark, is a global leader in the treatment of diabetes. According to the International Diabetes Federation, the number of adults living with diabetes is expected to rise to 780 million by 2045. The stock is one of my favorite plays in the healthcare space.

Based in Ireland, Ryanair is Europe’s largest airline group. The company is targeting 166.5 million passengers for 2023 versus 97.1 million in 2022. The stock has taken a substantial tumble this year and is down 50% from its 52-week high. However, I like the company’s business model, its strong hedges against higher fuel prices, and its ability to gain market share from weakened airlines in Europe.

Two additional stocks I find particularly interesting include MercadoLibre (MELI), the “Amazon of Latin America” due to its fast-growing e-commerce platform; and Deutsche Telekom (DTEGY), a German telecommunications company with a 48% ownership stake in T-Mobile (TMUS).

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