The future is hard to see. For example, few among us could have predicted the back and forth on trade policy this spring, let alone the market’s reactions to it.
On April 2, the Trump Administration announced 10% baseline tariffs on nearly all imported goods, with higher levies on 60 trading partners. Markets recoiled, and stocks dipped to near-bear territory. The market rebounded when the administration’s rhetoric cooled, then dropped when it got aggressive again. The pattern continued throughout the second quarter. These rapid and severe changes of direction make it incredibly hard to know what the future economic landscape will look like.
Rather than prepare for any single outcome, it’s best to prepare for any outcome. The good news: With a well-diversified portfolio tailored to your goals, you’ve already done that. This doesn’t mean you won’t feel some whiplash watching the market jerk around. But you can rest easier knowing you don’t have to bet your future on one scenario or the other.
International Stocks and Diversification
You may be hearing more about international stocks lately. They outperformed U.S. stocks during the second quarter and the first half of the year, which helps us make our broader point about the importance of diversification.
The Trump Administration’s tariffs are part of a broader trend toward deglobalization. (Think Brexit, Russia’s invasion of Ukraine, Covid-era supply chain problems and the first Trump Administration’s tariffs, to name a few deglobalization developments.) This trend is evident in global trade numbers: Foreign direct investment climbed between 1970 and 2007, and has fallen dramatically since.
In the U.S., retreat from global trade could drag on economic growth and push inflation higher, creating headwinds for stock and bond investors. But deglobalization has a silver lining for the well-diversified investor. The less connected global economies are, the less their markets are likely to move in sync with each other. The upshot: International stocks and bonds may provide more diversification away from U.S. assets than they have in recent decades.
That would be a welcome development. Correlations between U.S. and international stocks jumped from 0.54 in the 1990s to 0.87 between 2000 and 2022, meaning international equity allocations didn’t provide as much diversification as they once had. (The lower the correlation between two investments, the better they diversify each other.)
The rise in correlations might be reversing. U.S. and international stocks behaved very differently during the first half of the year. In the first half of the year, the S&P 500 rose 5.7%, while the MSCI EAFE gained 17.3%.
By diversifying your bets across asset classes, geographies, sectors, and industries, you reduce the risks associated with any particular outcome. In this case, diversifying internationally might help buoy a portfolio if U.S. stocks are hit by slower growth and higher inflation.
A Note on the Tax Bill
After a marathon session, Congress passed the Trump Administration’s tax and domestic policy bill, and President Trump signed it into law on July 4. The law includes extended and expanded tax cuts, including permanently extending lower marginal tax rates, the 20% business income deduction and increased estate and gift tax exemptions.
We’ll have more information in the coming weeks and months about how the new law may affect your financial plan. In the meantime, please reach out with any questions about the legislation or anything else that’s on your mind.
