Gregory Mankiw, a professor of economics at Harvard, wrote an editorial piece on May 18th, 2013 in The New York Times that included a list of the "what we know" rules that all investors should follow. Among other things, Mankiw argued for international diversification.
In a section titled "Smart Investors Think Globally", Mankiw argues that owning international stocks is an indispensable part of stock investing:
One widely documented failure of diversification is what economists call home bias. People tend to invest disproportionately in their home country.
Most economists take a more global perspective. The United States represents a bit under half of the world's stock portfolio. Because Europe, Japan, and the emerging markets do not move in lockstep with the United States, it makes sense to invest abroad as well.
I see no reason to regard a focus on American domiciled stocks as a "widely documented failure of diversification." One of the benefits that we as American investors have is that it is largely American corporations that have done a good chunk of the "globalizing" these past few decades. For instance, Mankiw points to "Europe, Japan, and the emerging markets" as areas that investors need to own. Even though I do not agree with that let's stipulate that is true. My next question is this: Why can't you just do that with the American stocks you are familiar with?
I'll give examples of each:
Mankiw mentions that investors should get European exposure. Why not just buy McDonald's (NYSE:MCD) stock? That accounts for 40% of McDonald's sales and operating profit, and gives investors exposure to Europe. McDonald's has 1,400 restaurants in Germany and over 1,200 chains in France. In fact, part of McDonald's explanation for weak earnings numbers lately has been the strength of the dollar against the euro. If you want to bet on a strengthening euro, you could do it on the backs of Big Macs and McNuggets by purchasing shares of a company that would allow a strengthening euro to translate into growing quarterly dividend checks in your pocket.
The next country Mankiw cites for needed exposure is Japan. The most straightforward way for an American stock investor to use common stocks to get Japanese exposure is to buy shares of Aflac (NYSE:AFL). When you read the balance sheet, you will see that Aflac is really a Japanese company camouflaged as an American insurance company. Check out this part from the company's latest news release:
U.S. life insurer Aflac Inc., which counts on Japan for almost 80% of its business, reported a better-than-expected 13% rise in quarterly profit but a weaker yen took a big chunk out of its premium income.
The yen has weakened sharply against the dollar since the Bank of Japan pledged earlier this month to inject about $1.4 trillion into the Japanese economy to fight deflation.
Did you know Harley Davidson (NYSE:HOG) is basically a bank that sells motorcycles on the side because it generates more money from the financing of motorcycles than the manufacturing of motorcycles? Well, Aflac is pretty much a Japanese company that does some insurance work in the United States on the side. Just as Harley Davidson is dressed up as a motorcycle company, Aflac is dressed up as an American company. This is another example of how you can get exposure to particular markets while staying within the realm of American securities.
And lastly, Mankiw mentions emerging markets. If you want to bet against the United States dollar and own a company that generates all of its profits outside the United States, it could be useful to take a look at Philip Morris International (NYSE:PM). Asia makes up 37% of its profits. The Middle East, Africa, and Eastern Europe make up 27% of its profits. Smoking rates in countries like Indonesia are increasing at 10-25% annual rates. The Marlboro brand is gaining market share in Asia. The company is planning aggressive expansion into Central Africa. If you want emerging markets exposure, Philip Morris International could be a decent way to cover your bases.
I do not mention these things to discourage you from international stocks. I have been purchasing BP (NYSE:BP) between $39-$43, and I will eventually purchase Anheuser-Busch (NYSE:BUD), Nestle (OTCPK:NSRGY), Royal Dutch Shell (NYSE:RDS.B), and two or three other international companies when the stars line up. My point is that you should not feel an obligation to own international stocks simply for diversification's sake. If you find a good international stock with a business model you understand and it trades at an attractive price, then great. You should buy it. But owning international stocks does not have to be a necessary part of your strategy. Despite what Mankiw advises in the New York Times, you can build a diversified collection of "global stocks" simply by investigating where certain American multinationals generate the bulk of their sales and earnings.