Despite a rebound on Friday, U.S. stocks have been caught in an early-year slide and are now trailing other markets year-to-date. In my weekly commentary, I go over some of the reasons behind that skid: fears over global economic growth, a poor retail sales report in the U.S. and an uneven start to the fourth-quarter corporate earnings season.

First, despite the relative economic strength of the United States, retail sales fell 0.9% from the prior month in December. Even after adjusting for lower gasoline prices, sales still fell. Adding to the gloom, the U.S. earnings season has been especially discouraging for banks, which are struggling with the lowest trading revenue in years.

Perhaps the bigger issue is investors are constantly reminded by the commodity market that global growth could stay sluggish. Oil prices slid further but rebounded by week’s end. What is more troubling: copper prices tumbled to their lowest level since 2009. While excess supply contributed to the fall in prices for both commodities, the decline in the more economically sensitive copper seems to point to more challenges ahead for the global economy.

Such concerns have been with us for a few months now, but the impact on stocks has changed. Unlike the past several years, U.S. shares are now performing worse than the rest of the world. The problem is simply that both expectations and valuations are particularly high for U.S. stocks. U.S. economic fundamentals appear solid, but U.S. equities are trading at a significant premium over other developed and emerging markets. The relative size of the premium makes the U.S. market vulnerable to any disappointment.

All of this underscores one of the basics of investing: Be diversified, and that means casting your net outside the U.S. as well. This is especially important today given that many international economies, although facing considerable obstacles, are likely to benefit from one major tailwind: central bank accommodation.

Unlike the Federal Reserve, most of the major central banks in the world will be easing rather than tightening monetary conditions in 2015. This week,the European Central Bank is expected to initiate its own version of quantitative easing, expanding its asset purchase program to include sovereign debt. Even central banks in emerging markets are now in an easing mode. Last week, the Reserve Bank of India cut its benchmark interest rate.

The bottom line: U.S. equities can move higher in 2015, but as we’ve already seen, the path is likely to be accompanied by much more volatility. In addition, international markets may benefit from less challenged valuations and the tailwind of central bank accommodation. We would not abandon U.S. equities, but this is a good time for investors to ensure that their portfolios are sufficiently diversified outside the U.S.

Source: Bloomberg.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. 

 

Investing involves risk including possible loss of principal.  Diversification strategies do not ensure profits in falling markets.   International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets.

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

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