Escaping Stock Market Double Hell

In an email last week I shared with you the letter I wrote to IMA clients, where I shared my views on the US market.  In this letter I’ll discuss the nuances of international investing. 

Escaping Stock Market Double Hell

Over the last few years, our portfolio has skewed more international, and this is the topic I want to address today. 

The US is a wonderful country and has many significant competitive advantages over the rest of the world. Despite all of its flaws, it has the most stable political system. It has great geography: It’s bordered by friendly neighbors to the north and south, and by mostly friendly oceans to the east and west. It has an abundance of natural resources. It is one of the largest democracies and has the right amount of capitalism (though we’ve been slipping in this department). We have the best capital markets, and the US is the best place in the world to start a new business, take risks and innovate. These factors led to the coronation of the US dollar as the world’s reserve currency.

Ideally, in a perfect world, we’d want to have a portfolio of only US companies. Not because we are patriots, but because our life at IMA would be so much easier. 

Let me explain all the extra headaches we incur when we own foreign stocks. European markets open 7–8 hours earlier than ours; Japan is 16 hours ahead. Thus, we have to place orders early in the morning, sometimes in the middle of the night. 

Our trading system, which links directly to US exchanges, allows us to buy or sell any US stock electronically, directly through our software. It is not linked to foreign exchanges, thus foreign trading comes with significantly more friction and consumes more time. Foreign stocks have multiple tickers, which constantly confuse our clients – this means we receive more inbound inquiries on them. US trading comes with zero commissions, allowing us to accumulate a position slowly, in tiny increments, with little effort. Brokers charge commissions on foreign stocks, so we have to be sensitive to how we are accumulating or disposing of a stock. 

I am sure I am missing half a dozen other headaches. Yes, foreign stocks are a big headache for the IMA team. We are not a masochistic bunch, so let me explain why we go through this brain and time damage.

Over the last decade the US has attracted the bulk of the capital flows, and the US stock market is trading at one of the highest valuations in US history. Historically, returns that followed such sky-high valuations have been mediocre at best. I wrote two books on this subject. How much you pay for a business, even if it is a great one, is important, as it is one of the key inputs determining your future returns. 

When we look for stocks, our searches are global. We look at the US and at foreign markets that have the rule of law. But our goal is to buy the stock that offers the highest risk-adjusted returns. For us to buy a foreign stock, it has to compensate us for the extra time and trouble involved – in other words it has to be a super-attractive investment. 

Let me give you a few examples.

When we looked at defense companies, we examined all of them, in the US and internationally. We bought a few in the US but found that European defense companies were a more compelling proposition. 

First of all, Europe has been sipping Chianti, Bordeaux, Riesling, and Earl Grey for the last thirty years while collecting peace dividends and significantly underinvesting in defense. The US, to a large degree, became NATO.

We have more enemies today than at any time in my lifetime, and they are stronger (China has a bigger manufacturing base than the US) and aligning with each other. There is an unthinkable war in Europe, where one country attacked another to steal its territory. China is contemplating invading Taiwan – a tiny island that produces the bulk of the world’s semiconductors. The Middle East is on fire. Rebels most of us didn’t even know existed are making the Red Sea unnavigable. 

And from the European perspective, the US is becoming a fickle friend. Europe is racing to create a $500 billion defense fund, per the FT:

Trump’s threat to withdraw US security guarantees from underspending Nato allies has spurred European capitals to explore more radical defense funding options, including joint borrowing that has traditionally been ruled out by fiscal hawks in Germany, the Netherlands and Denmark.

European defense spending is going up and will continue to go up, no matter who is in power and regardless of deficits. Thus, when we looked at defense companies, American counterparts were more expensive and had relatively shorter (though increasing) growth runways. We bought European defense stocks, and so far, it looks like we made the right bet.

On the surface, one of the main risks of buying foreign stocks is that we are making a bet against the US dollar. As you’ll see, this is a bit more nuanced than simply where stocks are listed.

I don’t know where the dollar will be over the next five or ten years. Nobody does. Currencies are priced relative to one another. Thus, to forecast the US dollar versus the euro, I’d need two crystal balls – one for the US and another for the EU. 

I don’t have even one.

There are a lot of policies the new administration wants to implement that may cause the dollar to appreciate. For instance, less regulation – if Musk succeeds – would be a huge positive for US economic growth. We need a lot more pragmatism in Washington, DC, something we’ve lost over the years.

But then, the US government embracing Bitcoin is probably one of the most idiotic policy ideas I’ve ever seen come from a politician (though there are contenders). It’s especially baffling when you consider that the only reason we’re not dealing with 20% mortgage rates and 30% car loans  – despite our $36 trillion (and growing) debt – is that the US dollar remains the world’s reserve currency. The US dollar doesn’t have good contenders, and this is why the US government watering the seeds of one makes little sense to me. (I wrote about the problems with Bitcoin here). 

Also, often foreign stocks are only foreign in name. This is where things get nuanced fast. Philip Morris International (PM) is listed on the NYSE but today gets most of its sales from outside the US. British American Tobacco (BTI), listed in London and also trading as an ADR (American depositary receipt) in the US  – despite having “British” in its name – gets half of its sales from the US and half from the rest of the world. 

We own Swedish and Canadian oil companies. When it comes to oil companies, the location of their assets matter far more than where the companies themselves are listed. Most of the oil assets that these companies hold are in Canada. We chose these companies not only because they’re significantly undervalued and have strong balance sheets, but also because they’re led by exceptional management teams who excel at running the business and at capital allocation – an uncommon trait in the commodity space.

Also, oil is a global commodity, and while many factors affect its price, it’s also indirectly a bet on a weakening US dollar, since oil is priced in US dollars. We have to take this into account when constructing our portfolio.

Then we have a UK company that makes components for the aerospace industry. However, aerospace is a global industry, and over the longer term, the company’s stock performance will be tied entirely to what the aerospace industry as a whole is doing. Its performance will be indifferent to where it’s listed. We bought it at a fraction of the valuation of its American counterparts.

We pay close attention to our concentration in a particular country, as well as to our exposure to specific currencies and industries. But as you can see, it’s a lot more nuanced and intricate than simply looking at where a company is traded. 

Our default choice it to buy American companies; but at the end of the day, our goal is to grow your wealth while keeping the volatility of your blood pressure low, so that you don’t have to worry about the markets. Today the average US stock is trading at a nosebleed valuation. High-quality, undervalued, well-managed foreign-listed stocks are where we’re finding opportunities to hopefully achieve this goal, even if it means more headaches for the IMA team. 

One more thought: In the late 1990s, value investors experienced both paradise and hell. As tech and dotcom stocks soared higher, there were many cheap stocks to choose from that were neglected by the inflating bubble. That was the paradise part – an abundance of undervalued companies to pick from while the crowd stampeded into the bubble. The hell, of course, was the pain of being left behind while the crowd uncorked champagne.

Today, if you only invest in the US, you’re experiencing two hells. Your stocks are underperforming, and even inexpensive stocks are expensive. Yes, welcome to double hell. European stocks, however, offer paradise today. True, Europe is not the place it used to be a few decades ago – which is precisely why nuance and stock picking are so important.  Value stocks always look less exciting than the ones everyone is talking about.

Key takeaways

• Despite the operational headaches, I’m looking international because US market valuations are at historic highs.
• European defense stocks offer better value and growth potential than US counterparts, driven by NATO’s $500B fund.
• “Foreign” is often misleading – companies like Philip Morris trade in the US but generate revenue globally.
• We’re in a “double hell” in US markets – value stocks underperform and even “cheap” stocks are expensive. Europe offers better opportunities.
• Currency risk isn’t simple – oil and aerospace companies’ performance ties more to global factors than listing location.