Mistaken views about international stocks by ADQ and GMO

Diversification and balance

My practical route to international investing

This post is about the best way to invest internationally. I’ll start with the wrong way and then explain a better way.

I’ve read a couple of reports recently that I disagreed with. The reports I will discuss recommend increasing allocation to international stocks and decreasing exposure to U.S. stocks. In recent years I have been moving in the opposite direction, more to the U.S. market.

The reports are by Cliff Asness et al. of ADQ and James Montier/Jeremy Graham of GMO. They are pretty high-profile American money managers. I disagree with them respectfully but fundamentally. That’s ok because that’s what the stock market is all about.

The basic rule of international diversification was explained by John Templeton, one of America’s greatest ever investors. He wrote more than 40 years ago in his maxim 15: “If you search worldwide, you will find more bargains and better bargains than by studying only one nation. Also, you gain the safety of diversification.” (Proctor & Phillips, The Templeton Touch 1983, 2012) p.153.

The authors would probably agree with this, as do I.


AQR Capital Management is a global investment management firm based in Greenwich, Connecticut. Cliff Asness is one of its founders.

Cliff Asness’ thesis is: “International diversification is still worth it, even if it hasn’t delivered for US-based investors in 30 years. Most of the US equity outperformance during this period reflects richening relative valuations, hardly a reason for raising or even retaining US over weights today. If anything, historically wide relative valuations point the other way.” (Emphasis added) As evidence Asness cites relative valuations of US and Other Equity Markets using the Shiller CAPE ratio. (ADQ)

Valuing a stock market – apples and oranges

Even if you accept the premise (which I don’t) that use of a p/e or use of CAPE is a way to value a market, the approach is fundamentally flawed. It can lead to comparing apples and oranges.

Let me use the example of the U.S. stock market and the Canadian stock market. In some ways the Canadian stock market should be comparable to the U.S.  It has comparable market regulation around timely disclosure, fraud investigations, accounting practices and both are advanced economies. Monetary and inflation conditions are not too dissimilar. The U.S. and Canadian economies are highly integrated.

The U.S. stock market is reported to currently have a p/e ratio of 26.7, the Canadian market 16.1. it doesn’t matter if these numbers are precisely accurate. I got them from the same source and thus they should be calculated in the same fashion. On this basis one could argue that the Canadian stock market is significantly underpriced relative to the U.S. I regularly read comments to that effect.

I know the Canadian market pretty well having invested in it for some 50 years. I have also been investing in U.S. stocks and internationally for about 25 years.  My feeling is that the Canadian stock market is currently no more cheaply or expensively priced than the U.S. market. How so?

The Canadian stock market is heavily weighted to oligopolies. These include the banks (five big ones), telcoms and media (three big ones), grocery stores (three big ones) and industrials (two big railways). At the expense of consumers, they all make lots of money but, as is normal with oligopolies, they have very limited opportunities to reinvest their cash flow in growth. Their markets are mature. Their lower p/e ratios are well deserved. To compare the relative valuation of the Canadian stock market and the U.S. stock market using market wide p/e’s or even CAPE is comparing apples to oranges.

That said, there are some wonderful Canadian companies well worth investing in (occasionally at bargain prices) so long as you look beyond the usual household name oligopoly stocks. As John Templeton would advise, you look for your bargains amongst stocks not amongst markets.

Price earnings ratios easily mislead

And as I noted, I do not accept ADQ’s premise that use of a p/e or use of CAPE is a good tool to value stocks let alone markets.

P/e ratios are at best a crude rule of thumb in valuing individual stocks. A proper valuation can only be done using a discounted cash flow assessment. My critiques of p/e ratios and non-stationarity of data are here, here and here.

Shiller CAPE has big flaws

The Shiller CAPE ratio was never held out as a way of valuing either stocks or markets. The original work suggested some correlation with future returns. But it has fundamental flaws. I explain this here, here, here and here.

Bottom line for me

I think it is simply wrong, in every way, to make sweeping generalizations about the price/value of different equity market based on comparing p/e ratios of the MSCI EAFE Index (which is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe) and the MSCI US.

What make sense is trying to assess the fair value of individual stocks as against their price no matter where they are located.

Let’s turn to views from GMO.


GMO LLC (also known as GMO and Grantham, Mayo, Van Otterloo & Co. LLC) is an American investment management firm headquartered in Boston.

James Montier of GMO has two warnings for investors in U.S. common stocks. First, profit margins are elevated and might mean revert. Second, any way you look at it he feels U.S. stock prices are overpriced and thus future returns will be low. But he offers the good news that many other stock markets around the world are quite attractively priced.

He puts it this way. About high profit margins he opines: “…if the era of big government is here to stay then profits as a percent of GNP can remain higher than they were in the past. As to the likelihood of this…as I have so aptly proved over the last decade, this is simply beyond my ken.” It’s beyond the scope of this post to deal with this issue. I invite readers to reflect on intangible assets in this connection.

And as to the priciness of U.S. stocks he says: “So even if one believes that fiscal deficits are here to stay and that profitability is structurally higher as a result, the U.S. market is still trading at around 30x (Exhibit 9). This dooms investors to low long-run returns. Even if we don’t get any valuation or margin mean reversion, investors are facing a return of around 3% real – hardly likely to be sufficient recompense for the risk of owning equities.” He goes on, “The good news is that many other markets around the world are considerably more attractively priced. Exhibit 11 shows the way in which the U.S. stands out in valuation terms.” (Emphasis added) Article


Montier’s partner, Jeremy Grantham, is of the same view about international stocks:

“But the main thing is avoid the U.S. Because of this rather strange, almost inexplicable bias. The U.S is so much more expensive this time around. In 2000, everybody was expensive. This time around the U.S is expensive and the rest of the world is not particularly expensive.(Emphasis added) Link

My thoughts about the views expressed by GMO are exactly the same as I expressed about ADQ. The fundamental flaw in their thinking is to compare apples to oranges and use the flawed tools of market p/e’s and market CAPE (which is also a p/e).


What’s interesting is that over the last while I have read a number of approving notes, reports and comments by commentators, passing on the ‘wisdom’ of the ADQ and GMO reports. I guess that’s how things get disseminated in the world of finance and how groupthink occurs at a macro level.

My experience with international stocks

In the last 25 years our family’s portfolio has included stocks of companies from Germany, France, the U.K., Hong Kong, Israel, U.S. and Canada. Today, however, we are about 58% in U.S. stocks and 41% in Canadian stocks, with no holdings from other countries. But we have true international exposure around the world.

How did we get here and why?

About 25 years ago I learned about home bias and also read John Templeton’s maxim 15 quoted above. Up until that point I had invested only in Canadian stocks. My thinking had been that in retirement I would depend on Canadian dollars and thus could avoid currency problems by sticking with Canadian stocks. This thinking was mistaken.

So, I started investing in a variety of international and U.S. stocks.


A word about terminology. For me as a Canadian, strictly speaking, a U.S. stock is international. In this post, to avoid confusion, I’ll stick with the terminology used by ADQ and GMO and call all non-U.S. stocks International.

I mention this because since I started this blog almost four years ago my posts have been viewed by readers from over 150 countries around the world. The majority, however, are North American. Readers in Singapore or Italy might think of U.S. stocks as International. No matter, they will understand.


Investment in many international companies can be achieved through American Deposit Receipts (ADRs) in the U.S. The companies are obliged to comply with U.S. accounting and disclosure rules. There are over 400 international companies traded in New York as ADRs.

Early 2000’s

In the early 2000s after going back into the market following the Dot Com crash, I started to add U.S. stocks to our portfolio and also began experimenting with adding international exposure. Some Canadian companies I bought had international operations. That added a measure of diversification. Some U.S. stocks I bought also had international sales, to the same effect. It was an education to see the impact of currencies on foreign sales of Canadian companies and U.S. companies and on the relative price of their shares. For example, a U.S. company selling abroad would suffer currency losses on foreign sales from a strong U.S. dollar but the price of the share might see a currency appreciation vs. the Canadian dollar at the same time.

I learned many valuable lessons. Canadian companies expanding into the U.S. market often suffered. Canadian companies expanding into Central and South America might get growing sales at the expense of lower margins. My general experience was that some Canadian and U.S companies did international operations and sales well and others did them badly.

I came to the position that, for balance and diversification reasons, I wanted two different kinds of Canadian and U.S. companies: those with 100% of their sales in their domestic markets and those with substantial foreign sales.

As for international companies, our purchases began in the early 2000s and the last of them was sold about three years ago. I purchased stocks in companies based in the U.K, France, Germany, Hong Kong, China (domestic PRC operations with listing in H.K.) and Israel. I typically held those stocks for three or more years. Ultimately, I concluded that they were not superb companies up to my standards. For international exposure, I eventually settled on Canadian and U.S. companies with international operations and sales. For our current portfolio and a description of global scope of their operations, see here.

A cautionary tale

As an aside and a cautionary tale, I’ll tell you about the German tax authorities. We were earning a good dividend from the world’s largest chemical company, BASF. The Canadian/German tax treaty specifies that Germany will only withhold a tax of 15% on dividends. But they were withholding 25%. I used these withholdings as a deduction in Canada. Then the Canadian tax authorities said I could only deduct 15%. So, I applied to the German tax authorities to recover the 10% over-withholding. It took me three years of agony. I could write a small book on the ordeal. They were finally convinced by my references to their operations as being Kafkaesque.

Every country has treaties with other countries about tax withholding on dividends. If you are investing internationally, you need to know these rules.


No matter where you live you have to have an international perspective and reach. I tried to invest in companies in other advanced economies but ultimately came to the view that there were not enough really superb companies on offer. Eventually, with care, I found Canadian and U.S. companies with sound foreign operations and sales.

I don’t think it either possible or useful to assess the relative price to fair value of international stock markets and U.S. markets as ADQ and GMO do. It risks an apples to oranges comparison. Also, we price stocks not markets.


You can reach me by email at rodney@investingmotherlode.com

I’m also on Twitter @rodneylksmith


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