Imagine if you could board a time machine, go back to 1910, and invest for the next 100 years in the stock market of any country in the world.
Published at 12:46 a.m. Updated at 9:00 a.m.
Which country would you choose?
If you are like many people, you will make the obvious choice: the United States.
Everyone knows that the American stock market has done extremely well over the long term.
But you know what? Canada beat the United States from 1910 to 2010.
The annualized compound return for Canadian stocks was 9.26% during this period, compared to 9.13% for U.S. stocks, according to calculations by Benjamin Felix, chief investment officer and portfolio manager at PWL Capital.
So $100 invested in Canadian stocks in 1910 would be worth $701,648 after a century, compared to $622,895 if they had been invested in American stocks. These amounts do not take inflation into account.
Why am I telling you this? Because I notice a constant when you write to me.
I notice you really, really like American stocks. And the main index which represents the 500 largest publicly traded companies in the United States, the S&P 500.
I’ve lost count of the number of readers who swear by the S&P 500. As I’ve written before, the S&P 500 is the Taylor Swift of the financial world.
This reputation is deserved. Since 2010, U.S. stocks have had an annualized compound return of 14.63%, compared to 8.43% for Canadian stocks. The American stock market is rising sharply because the profits of American companies are rising sharply. It’s that simple.
The American stock market alone represents more than 50% of all stock market capitalizations in the world. So investing in the United States is essential.
Now that that’s said, here’s why your love affair with the S&P 500 could end badly.
First, one of the most powerful forces in finance is mean reversion.
Stock returns often work like a seesaw. The higher they go, the lower the returns that can be expected in the future. And the more they fall, the more the expected returns increase.
The S&P 500 has been record generous with investors since 2010. No one saw this outperformance coming.
The American stock market could continue to outperform in the coming years. It could also underperform and regain its performance in the long term. Nobody knows.
Then, like all stock markets in the world, the American stock market has already experienced long periods of slump. From 1965 to 1982, the S&P 500 did not grow. Investors have endured 17 long, difficult years, only to find themselves back at square one.
More recently, the person who invested in the S&P 500 in the year 2000 still hadn’t made any money in 2011, even including dividend reinvestment.
I don’t know about you, but 11 years without seeing the glimmer of a profit is a long time. The risk is that an investor ends up having enough of the red numbers in his portfolio, and decides to sell to change strategy.
It’s a bit like changing lines at the checkout. As soon as we change, the line we just left starts moving forward. And the one we just joined gets stuck.
An often heard argument in favor of the S&P 500 is that it contains the “Magnificent Seven”, that is to say the big companies like Apple, Google and Meta, which are changing the world, and which have no equivalent in other countries.
It’s true. But an analysis of the largest American companies from 1927 to 2023 carried out by the firm Dimensional showed that they tended to underperform the market in a horizon of 5 and 10 years after having reached the top 10 of the largest companies. So betting on permanent outperformance of the giants is historically out of the ordinary.
See the Dimensional analysis (in English)
Finally, I think that many people feel “in their gut” that the American economy is more dynamic and more diversified than the economies of several countries, including Canada. And therefore it has better long-term growth prospects.
It’s quite possible. But research tells us that the rise in GDP and the rise in the stock market are not linked. Several countries that have experienced strong GDP growth have historically had disappointing stock market returns. The explanation being that high growth expectations are already reflected in stock prices.
INFOGRAPHICS THE PRESS
So how do I invest my own money?
A large study last year by researchers at the University of Arizona showed that the optimal portfolio for an investor in a country like Canada has historically been to have about a third of their investments in stocks of the domestic market, and the rest in international stocks, weighted according to the size of each country’s markets.
Read the study on the SSRN website (in English)
The all-in-one exchange-traded funds (ETFs) that I regularly talk about here are built this way. In a single fund, we have everything we need in our portfolio. At BMO, the “growth” fund is the ZGRO fund. At BlackRock, it’s the XGRO fund. At Vanguard, VGRO. “Balanced” funds, less volatile, are ZBAL at BMO, XBAL at BlackRock and VBAL at Vanguard.
With such an approach, we still have a lot of American stocks. But they do not dominate our investments. This is the strategy I adhere to.
Is this the right one? We’ll talk about it again in 30 years.
And the elections?
Speaking of the United States, what do we think of the impact of the presidential election on the markets?
With just over 3 weeks until the election, electoral uncertainty does not seem to be translating into more stock market volatility. The S&P 500 has been going from record to record for months. Volatility is lower than average. We’ll see what the rest of the year has in store for us.
What we do know is that election years tend to end with rising markets in the United States. And that, regardless of whether it is the Democrats or the Republicans who are in power, the financial markets are up two years out of three on average.
Everyone likes high returns. Few are willing to do what it takes to get them: nothing.
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