While we all understand over the long run a diversified portfolio has provided better returns and lower risk, over the past 1-2 years it has also been the main factor of underperformance. Apart from a few exceptions, being invested in anything but US stocks has been hazardous to your portfolio. Knowing one of the most powerful phenomenon’s in investing (and life for that matter) being reversion to the mean, I know this US centric investment thesis can’t go on forever. As such, each week we scour the world looking for investing opportunities outside the US that will present both good risk/reward and a means to a better diversified portfolio.
One country that fits all the requirement and is on our radar is Italy using their ETF, EWI, as a proxy. You can see in the middle pane of the chart below, the Italian stock market has fallen more than 29% since it peaked in the middle of last year. The decline was nicely contained within the blue downtrend line as each time it tried to rally above it, it was promptly rejected and prices continued lower. That all ended last month when price broke out, quickly fell back to retest the blue downtrend line and then immediately propelled higher. The other thing that should jump out at you since the breakout is price has continued to make higher highs and higher lows, which is the definition of an uptrend. This is one of the confirmations we look for before investing as trend followers want to invest only in things that are trending up.
While finding an investment that has fallen, has bottomed and begun a new trend higher is what we strive to find, we have found in today’s market there is no sense in using client investment dollars unless there is a possibility it can outperform a US alternative. The bottom pane in the chart is a ratio of the performance of the SP500 to the Italy ETF. You can see up until the start of this year where the ratio peaked, being invested in the SP500 had provide a better return by 45%. Since that time three important events have occurred 1) the ratio broke below the blue uptrend line 2) the ratio broke below the blue horizontal support 3) the ratio is forming lower highs and lower lows. These are all confirmations informing us the trend for the ratio has changed from up to down.
With the US markets struggling to go higher and looking very tired (more on that in another post) Italy looks as if it is worthy of some equity investment dollars. Rather than add to equity exposure, a swap from a US equity into Italy seems worthy of consideration.