United States 1, Everyone Else 0

The stock market clearly shows that the US is riding high and Europe is left in the dust. Is there still a point to regional diversification in such a case? Or does this remain the key to success?

The US stock market is continuing its climb to unprecedented heights. There seems no end in sight for the America First trade, which accelerated following Trump's election victory. At the beginning of December, the S&P 500 shattered its record… for the 55th time this year. Despite ballooning national debt and uncertainties around monetary policy, investors remain enthusiastic about the US and Trump's policy plans. This optimism about US resilience has revived a controversial debate. With US stocks outperforming almost everyone else for over a decade, does it still make sense to diversify investments to include other regions?

Diversification dilemmas

Diversification sounds very sensible. Don't put all your eggs in one basket, because they will all break if that basket fails. When you diversify, a bad investment can be compensated for by other, better ones. However (as of 9 December 2024), the S&P 500 has risen by around 28% so far this year, and diversifying investors are wondering if their approach still makes sense. To put that in perspective: the MSCI World ex USA, an index of 22 industrialised countries excluding the US, had made it to 8% by 29 November 2024. Although 8% is perfectly respectable (just look at Belgian government bonds or savings accounts!), it compares poorly to US stocks' performance. Anyone who stuck with traditional diversification models such as the 60/40 model (60% stocks and 40% bonds) also missed out on a lot of returns this year.

Why the US is so (seemingly) unbeatable

While various other major economies stagnated or even shrunk in recent years, the US has held firm. Despite the Federal Reserve's aggressive monetary policy, the country showed steady economic growth, partly driven by a strong labour market. Of course, the US also enjoys advantages other countries don't (all) have, with the dollar as global currency, a culture of innovative entrepreneurship, a strong consumer market, a leadership role in technology and a dynamic capital market. This heady cocktail intoxicated stock markets over the past decades. Weighting of the US in the global stock market kept going up. At the beginning of 2024, the US market represented 60.5% of total global market capitalisation, a significant increase compared to the early 20th century. Back then, the US was only good for 14.5% and the UK was the largest market at 24.2%.

Europe less attractive

Investing in Europe has been rather less profitable as a strategy for years now. With a lethargic stock market, a fragile currency, a divided political system tending to crisis (most recently in France and Germany), stagnating economies and war in the backyard, the picture here is not so rosy. Europe also continues to struggle with higher energy and production costs, partly due to dependence on foreign sources. These challenges limit the competitiveness of European businesses, while US companies benefit from lower costs, less regulation and a more stable energy supply. Those challenges could become even worse in upcoming years. Trump's plans to cut taxes and ease up on regulations make US stocks more attractive than ever, even as Europe fearfully awaits Tariff Man's next move. Europe is taking hits from all sides, making investors wary. At USD 63,000 billion, the total value of US stocks is currently four times higher than the value of all European stock markets combined. Ten years ago, that was less than twice. The Stoxx Europe 600 Index is currently trading at a record 40% discount to the S&P 500, and this year's underperformance is shaping up to be one of the worst cases ever.

Now what?

While investing entirely in the US may be very tempting given the impressive performance and consistent benefits, such concentration does carry a risk. History has shown that even the strongest markets are not immune to correction. Examples include the dotcom crash in early 2000 or the 2008 financial crisis, when the US was affected first and worst. Market exuberance is always corrected sooner or later. Certain factors could also change the playing field. America's budget deficit is growing unsustainably fast, the interest burden on its huge national debt is increasing and geopolitical tensions remain a risk. And while Trump's second term in office was seen as a positive for US stocks, decisions he takes could also easily send shockwaves through the markets.

Role of alternative regions and asset classes

European stocks may be less popular right now, but that low valuation also offers some nice opportunities for patient investors. A 40% discount on US stocks could indicate a buying moment. Other regions, such as Asia and emerging markets, are deserving of attention as well. Although they come with their own challenges, they also offer long-term growth potential, partly due to a fast-growing middle class and demographic advantages. Moreover, regional diversification can help mitigate currency risk and exposure to different industries and economies makes for a more robust portfolio. Alternative investments, such as real estate and infrastructure, offer other interesting diversification opportunities. These asset classes are less dependent on stock market volatility and can produce stable income streams.

Diversification for a more robust investment strategy

The US market continues to act as an impressive growth engine, but blind confidence in a single region is not always smart. Adopting a more balanced strategy can help protect your portfolio against unpredictability. Making a choice between focus and diversification is not easy. In this rapidly changing world, however, a diversified approach remains one of the most important contributors to a robust investment strategy. By investing in different regions, industries and asset classes, you can minimise the impact of unanticipated events and maximise the chance of stable, long-term growth.

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