The primary motive for international diversification has been to take advantage of the low correlation between stocks in different national markets. Thus, if international correlations go up, there’s less reason to buy foreign securities.
According to Ibbotson Associates, Chicago, correlations between the Standard & Poor’s 500 Index and Morgan Stanley’s EAFE (Europe, Australasia, Far East) Index, a widely-used international benchmark, was around 0.6 in the 1970s, dipped as low as 0.25 in late 1996, shot up in late 1998, and gradually rose to around 0.9 in mid-2005. (A 1.0 correlation indicates a perfect match while a negative number shows assets that tend to move in opposite directions.)
The picture looks a lot different, though, if you measure by annual instead of monthly returns and by 10-year rather than five-year periods. The same dip is evident, through the mid-1990s, but the recent rise in correlations has merely been back to 0.7, about the same as it was 25 years ago. Thus, the longer your time horizon, the greater the net benefit international investing can provide, from lower correlations.
