International Markets and Rule of Law

Harry MamayskyAdvisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

Academic work shows that openness, rule of law, and legal protections are associated with investor inflows to global stock markets. Based on such considerations, non-U.S. stocks don't look very good.

Emerging market and non-U.S. developed market stocks have underperformed their U.S. counterparts for the last several decades. There are several potential explanations for this underperformance. It is possible that the risk premium for holding U.S. stocks is higher than the risk premium associated with holding international stocks. But given that U.S. stocks are also considerably less volatile than international stocks, this is unlikely to be the reason.

cumulative returns

Another reason might be that capital is not perfectly mobile across countries (i.e., foreign investors either cannot or do not want to own “enough” U.S. stocks), and because of unique local conditions (i.e., a heavily equity-reliant and productive corporate sector), U.S. stocks have structurally higher expected returns than stocks from other countries, despite having lower risk. This is not the focus on my piece, but it is a plausible explanation.