American Exceptionalism May Be Dying. How to Make the Best of It.

The dollar’s slump may be a sign that global investors are shifting out of U.S. assets. (Prakash Singh/Bloomberg)

U.S. stocks are defying worries that America’s best days as the global market leader are over. It isn’t clear if American exceptionalism, as it’s known, is really dead. But if it is waning, there is a way to make the best of it: Own more foreign stocks in your portfolio.

The is up about 10% for the year, having largely shrugged off tariff turmoil, threats to the Federal Reserve’s independence, and other examples of what critics call President Donald Trump’s overreach.

Despite the overhang from Trump’s trade war and other executive actions, foreign stocks are faring even better. The iShares MSCI ACWI ex U.S. exchange-traded fund, for instance, is up 21% this year, led by gains in Japan, China, and European markets.

Foreign stocks are getting a lift from several tailwinds. A big one for U.S. investors is the decline in the U.S. dollar, down 7% this year against a basket of major foreign currencies. A declining dollar lifts the value of foreign assets when converted back to U.S. currency.

The dollar had been overextended and may be giving up some gains. But its weakness may also be a sign that global investors are diversifying out of U.S. assets. Reduced global confidence in U.S. leadership may be contributing to weaker demand for the country’s stocks and bonds as investors lose faith in America’s historic position as a financial haven.

The dynamic makes a strong case for diversifying outside of U.S. assets, says Marko Papic, chief strategist at BCA Research. “American investors have a real problem thinking about currencies,” he says.

This home-country bias extends to portfolios. Most U.S. investors are chronically underinvested in foreign stocks, with the average U.S. stock investor holding 81% of their total equity allocation in U.S. stocks, according to a Morningstar analysis of Bloomberg data.

U.S. stocks comprise about 65% of global stock market value, so one approach is to devote about 35% of your equity allocation to the rest of the world. An easy way to do that is with index funds that charge very low annual expense ratios and provide exposure to markets outside the U.S.

Funds to consider include the Fidelity Global ex US Index fund, the iShares MSCI ACWI ex US ETF, and the Vanguard FTSE All-World ex-US ETF.

Papic takes it further. Americans who get paid in dollars already have a sizable domestic currency exposure, he argues, so workers should consider as much as a 70/30 international-to-U.S. split in their investment portfolio. Retirees who no longer earn a paycheck could consider a 50/50 split, he says.

International sales account for approximately 41% of S&P 500 revenue. For that reason, some advisors take a more domestically oriented approach. Andrew Briggs, director of portfolio management at Plaza Advisory Group in St. Louis, recommends a maximum allocation of about 15% non-U.S. stocks for his clients. “American exceptionalism was and is real,” he says.

But U.S. large-cap indexes are loaded with tech—nearly 40% of the S&P 500. That makes the U.S. a higher-growth market, but it’s also much pricier. The S&P 500 has a price/earnings ratio of 25, versus 17 for the MSCI EAFE Index, which includes 21 developed-market countries around the world, excluding the U.S. and Canada.

“The U.S. is an expensive place to buy growth,” says Ryan Snover, managing partner of Aristia Wealth Management in Nashville.

It’s too early to say whether Trump’s moves to reshape the global economy will result in a new world order. The U.S. Supreme Court is expected to weigh in on the constitutionality of some of the administration’s tariffs. And countries the world over are forging new alliances that exclude or minimize U.S. involvement.

Either way, investors should benefit from a healthy international allocation. The S&P 500 may still fare well as a bet on tech and other major U.S. growth themes, but spreading your bets abroad may be a good insurance policy if there’s an accelerating shift away from the U.S.

Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com