As I’ve written before (Parental Discretion is Advised; A Euro, a Yen, a Buck, or a Pound; The CIA Guide to International Investing), international mutual funds are an essential part of any investor’s portfolio. There’s an excellent article on global investing in the June 3rd New York Times: An Around-the-World Ticket for your Portfolio. 

 

As you’d expect, the stock markets of Western Europe are highly correlated to the U.S. market. Makes sense, doesn’t it? A good portion of BMW’s profits come from the U.S., so if the U.S. economy turns down (and the U.S. stock market), so does BMWs profits and its stock price on the German exchange. Also, as you’d expect, the stock market movements of emerging counties, i.e., Brazil (68%), China (53%), India (43%), Russia (35%), are not as closely correlated with the U.S. market as are the Western European markets. (Of course, they’re also more volatile.)

 

There are two surprises in the New York Times article. The first is the degree of correlation. Over 80% for Western Europe. The U.S. and Western European markets move together.   The second surprise is the uniqueness of the Japanese market. Movements in Japanese stock prices have only a 29% correlation with movements in the U.S. stock markets. That’s surprising because Toyota sells so many cars here and we all own at least one Japanese made TV.  But it goes to show that the biggest driver of any economy is what’s going on inside a country, not how much it exports.  Just like the Japanese culture, there are many unique aspects to the Japanese economy.  What’s also nice about Japan is it’s the second largest economy in the world and offers the legal and accounting safeguards of a mature county.   Thus, you can gain diversity without emerging economy risk.

 

Conclusion:   Diversify beyond Europe, and be sure to include Japan, in your international mutual fund investments.