Last year was another stellar year for the domestic stock markets, with the S & P 500 finishing the year up by nearly 14%. This was on top of an outsized gain in 2013 of more than 31% by the S & P 500 Index. Other than mid-cap stocks, which posted returns in the mid-teen range, and REITs, which were up nearly 30%, no other asset class posted double –digit gains last year.

The disparity between domestic and foreign stocks was as wide as I’ve seen in many years, but most of the variance had to do with currency swings. In other words, because the U.S. dollar rose significantly last year, it negatively impacted foreign stock and bond investments. More simply, there is an inverse relationship between foreign asset prices and the U.S. dollar so when the dollar goes up, foreign prices drop artificially (I can write another blog about why the dollar rose verse other currencies, but that is for another time.) Nonetheless, last year was anything but a banner year for asset classes not domiciled in the U.S.

Investors that have constructed portfolios around global diversification, which is includes domestic and foreign stocks, as well as other asset classes, were probably disappointed with their returns last year relative to popular market indices like the S & P 500 Index, but they probably shouldn’t be. Why? If they compared their performance to that of a more diversified index as opposed to a narrow index like the S & P 500 Index, then they would have been less disappointed. Comparing one’s globally diversified portfolio to one narrow index is akin to comparing apples and oranges just because they are both fruit.

It is extremely difficult (and virtually impossible) for investors and professionals to figure out what markets and/or regions are going to outperform in any given year. Markets move in different cycles, and those cycles can be short or long term, and change relatively quickly with very little advance notice. That’s why it is so difficult to accurately predict when a cycle starts or ends. As an example, emerging market stocks, which had average annual returns approaching 22% from 2003 through 2009, had a more challenging period since 2009, which saw their average annual returns decline to about 2.3% through the end of 2014. In fact, when you look across the pond, most foreign developed and emerging markets have had inconsistent performance since the financial crisis, leading some to wonder whether owning any foreign stocks makes sense anymore. People like Jack Bogle, who founded Vanguard Mutual Funds, recently recommended that investors should ignore foreign investing overall. I beg to differ with Mr. Bogle, whom I respect, because the opportunities for growth and possibly more attractive returns lie outside our borders.

After a six year bull-market is domestic stocks, they have become less attractive from a value standpoint while other areas of the world have become more attractive. All things being equal, asset prices that have lower valuations tend to have higher expected returns. This doesn’t mean that domestic stocks will underperform and foreign stocks outperform. The market doesn’t work quite that way because of headlines and data flow, which can overwhelm rationale decision making. The main point is, don’t let the headlines dictate your portfolio allocation decisions.

Here are some possible opportunities to look for in 2015:

• Global diversification continues to make sense regardless of the headlines. I believe that investors can improve long-term returns by including more than one or two asset classes in their portfolios.

• Don’t abandon foreign investments because the media says so and because famous investors (i.e., Jack Bogle, etc.) say so. The U.S. represents far less of the overall global stock market than it used to so having exposure to pure foreign investments makes sense in the world we live in today.

• Energy-related investments such as natural resources stocks and Master Limited Partnerships (MLPs) have declined substantially since the end of last year due to declining oil prices, though MLPs finished the year up near 9% (they had been up near 18% prior to the oil price meltdown). Despite the drop in oil prices, it appears our energy renaissance remains intact, but it will have to adjust to the global market environment. More importantly, because these asset classes do not mirror more traditional stock and bond investments, they are excellent long-term diversifiers.

• Global real estate stocks. This area has had good performance over the past few years, but has trailed that of domestic real estate investment trusts, or better known as REITs. U.S. domiciled REITs have been one of the best performing asset classes over the past five years, but valuations are starting to look unattractive. Comparatively global real estate has not done nearly as well because of the foreign impact. But therein lies the opportunity.

• Bonds had a surprisingly strong year in 2014, due mostly to the decline in interest rates. While I do not anticipate interest rates declining further, bonds continue to make sense in long-term portfolios for the value they add—shock absorber when stocks are not acting well. At this point in the interest rate cycle, it is time to rethink your bond allocation and focus on shorter-term bonds and/or bond funds that will help cushion any decline due to potentially rising interest rates.

Best of luck to you in 2015!

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