Why You Should Care About Foreign Markets
As an investor and a US citizen, what happens to the American economy is important – not only to your portfolio but also your job and quality of life. Domestic stock market performance is usually the only financial data most investors follow while economic reports like unemployment figures and quarterly GDP are given priority over others. The data investors usually check is insulated to the US and doesn’t take into account outside influences.
In the modern economy though, there’s no such thing as a truly independent market. The advent of globalization has connected all countries to a single global economy which means that events happening overseas can impact the domestic economy.
Globalization and your portfolio
In the information age, technology is the biggest driver of the global economy. The proliferation of IoT and smart technology has connected the world in a way that’s never been seen before in human history. What that means is that investors need to take into account international economics even if they only hold a portfolio of US stocks.
Many US companies have operations overseas with a large portion of their earnings being derived from international sales. Investors holding Dow components or other large-cap stocks will invariably end up investing overseas in some capacity as a matter-of-fact. That means that companies are subject to foreign currency exchange risks as the US dollar fluctuates in value relative to another countries currency. Profits can be amplified by this effect or muted as some profit is lost when converted back to US dollars.
Small-cap companies tend to be relatively unaffected by foreign markets. They usually don’t have any international operations and business operations are dependent upon a local market or economic factor. While some may import goods or materials from overseas, most don’t have economies of scale to engage in such business practices. However, holding a portfolio of small-cap stocks ignores proper diversification and is riskier than maintaining a diversified portfolio of small and large cap stocks.
Another consideration when it comes to international influence is how interest rates between countries differ. Not only does it impact foreign exchange rates, but it also impacts commodity values and investor interest in other countries. If one country has higher interest rates relative to the US, investors may begin pouring money into that economy.
Not all investors hold to the same belief that international markets matter to investors. Noted investor and founder of The Vanguard Group has stated that he thinks investors need only invest in an index fund like the S&P 500 and let it grow for several decades. While some evidence suggests that holding an index fund over a long period of time is a valid investment strategy, the push for a more interconnected commercial base around the world means that even a domestic portfolio will be impacted by overseas markets.