Why the Dow's Trailing the World

From the news you've heard about the U.S. stock market, you might think that the Dow Jones Industrial Average (INDEX: ^DJI) is performing better than any other country's market index. Last year, that was largely the case, as even a relatively flat performance from U.S. stocks was enough to shoot past declines in most markets around the world. Yet even though some troubling news has continued to come from overseas to start out 2012, several of the most popular international stock markets are actually beating the Dow so far this year.

Why owning international stocks is smart
Diversification is a powerful force in your investing portfolio. The basic idea of diversification is that by not keeping all your eggs in one basket, you'll avoid seeing a complete loss if something goes wrong with the stocks you pick. If you own 20 stocks instead of two, your odds of a complete loss are dramatically lower -- and although your potential gains also get watered down, that's a tradeoff that most investors are willing to make.

Even if you own shares of many U.S. companies, adding international stocks to your portfolio can broaden your portfolio's diversity. By giving your assets a wider geographical reach, factors like local macroeconomic conditions and place-specific disruptions won't have as big an impact on the value of your holdings.

Who's up and who's down?
Looking at how things stand around the world gives some interesting results. With the Dow up about 6% so far in 2012, here's how some major international markets are faring.

  • Emerging markets. Emerging-market stocks have attracted a lot of attention lately, as fears that a long streak of extremely strong growth rates could finally come to an end led to some major declines last year. China's Shanghai Composite (INDEX: ^SSEC) fell 20% last year, while India's Sensex (INDEX: ^BSESN) dropped 24% and Brazil's Bovespa suffered an 18% drop.

    But so far this year, the tables have turned. The Indian stock market in particular has risen sharply, by about 13% year to date. But China and Brazil have also posted gains in excess of the Dow's rise. Optimism that the dip in growth rates might not be as bad as expected could be fueling the rebound -- or it could merely be bargain-hunting investors capitalizing on good value overseas.

  • Japan. The story in Japan closely resembles what investors saw in the emerging markets. A 17% drop in the Nikkei (INDEX: ^N225) in 2011 was followed by a nice gain so far in 2012. After a long period of a very strong currency, the Japanese yen has given back some ground against the U.S. dollar recently. That's good news for Japanese exporters, which have long labored under the disadvantage that an ever-strengthening yen placed on them.

  • Europe. As you might expect, Europe has fared a little worse than many of its counterparts around the world. Even after declines in major European markets during 2011, including the U.K.'s FTSE 100 (INDEX: ^FTSE) , the German DAX, and France's CAC 40, gains have been hard to come so far in 2012. The FTSE 100 and CAC 40 both trail the Dow, although the German stock market has more than doubled the Dow's year-to-date returns. With concerns about sovereign debt spreading across the continent, only Germany's economy seems to have eluded the doubts that the crisis has raised about companies throughout Europe.

Go where the gains are
Problems like the sovereign-debt crisis in Europe and slower growth in emerging markets demand your attention. But the U.S. has its own problems, and closing your eyes to overseas stocks leaves you fully exposed to any speed bumps the U.S. hits in its attempt at economic recovery.

As the global economy takes precedence over more locally driven economic activity, the companies that have the ability to compete the best have huge growth opportunities in front of them. Unless you truly think U.S. companies will dominate the rest of the world in every aspect of business, you can't afford to ignore the potential that foreign stocks hold. As more foreign companies gain power over important industries, you may see the Dow struggle more and more to keep up with international markets.

The quarterly earnings season can give you a lot of insight into how companies are performing internationally. The Motley Fool's brand-new special report looks at five stocks that investors simply have to watch this earnings season, and it includes companies that owe much of their growth potential to overseas opportunities. Take a look at this free report, and get the scoopbefore these companies report.

At the time thisarticle was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned. You can follow him onTwitter. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Fool has adisclosure policy.

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