Investors wary of concentration risk in their portfolios following the latest rout in the artificial intelligence trade could take a look at developed markets — especially in Japan and Europe. Last week’s action underscored again a trend that has been ongoing for some time. While AI stocks have been getting punished — with the iShares Semiconductor ETF (SOXX) down 3% last week and off more than 10% in October — those outside the tech sector appear to be in good shape. The latest pullback also stresses the importance of a diversified portfolio, one that can continue to climb alongside the AI trade while also offsetting some of the theme’s sharpest drawdowns. It’s a hard task for many, given that tech alone represents a roughly 40% weighting in the S & P 500. A look abroad reveals a similar problem: Together, South Korea and Taiwan account for nearly half of the iShares Emerging Markets ETF (EEM) , thanks to the sheer dominance of those countries’ chipmakers. EEM is down by more than 6% in October. The iShares MSCI South Korea ETF (EWY) is down almost 14% this month, while the iShares MSCI Taiwan ETF (EWT) is off close to 5%. JPMorgan Asset Management’s David Lebovitz said that the firm has a constructive long-term outlook in both Japan and Europe, which the global market strategist said could act as complements to U.S. stocks over the next 10 to 15 years as they each have durable trends outside of AI to drive upside. To be sure, there are still near-term risks that investors should be aware of. Lebovitz said that the firm is currently overweight Japan, but is market weight in Europe where it is carefully watching for attractive entry points amid some of the ongoing volatility. He added that the firm reduced its overweight exposure to emerging markets, following the rapid ascent in South Korea and Taiwan. This is roughly based on a traditional portfolio of 60/40 stocks and bonds, with 40 percentage points in the stock sleeve allocated toward U.S. equities, and 20 percentage points in non-U.S. names. The non-U.S. allocation is typically evenly split between Japan, Europe and emerging markets, he said. Still, there are different factors supporting each market. Here is the case for Japan and Europe. Japan Japan equities have enjoyed a tailwind this year, with the iShares MSCI Japan ETF (EWJ) higher by more than 17%. While that falls short of the advance of the South Korea ETF, up 62%, or the Taiwan ETF, up 69%, Japan’s market also has a more balanced weighting across sectors that makes it more defensive against some of the wild swings in the other two. Among the biggest changes in the country have to do with changes to corporate governance, including the encouragement of companies to eliminate idle cash and focus more on shareholder returns, that’s meant to support growth. Lebovitz also highlighted the improving nominal growth story in Japan, meaning that the growth measured in current prices before adjusting for inflation can support earnings and boost equity returns. What’s more, a cheap yen relative to the dollar could also contribute 2.4% to expected returns, even if margins continue to be a drag, he said. Japan can also offer investors AI exposure, thanks to the strength of its technology companies and its manufacturing sector that can help the country start to catch up to other nations. The case for Europe Lebovitz said the firm has also turned more constructive on Europe, where companies can continue to grow and its stocks are less expensive relative to the U.S. A stronger currency is expected to contribute about 0.5 percentage points to expected returns, he added. It also gives investors a different mix of exposures compared to the U.S. market. Instead of tech, companies tied to industrial and manufacturing businesses in Europe could continue to benefit from the ramp up in defense spending there. To be sure, Europe’s market also offers its own challenges, namely an energy crisis and political risks , as well as the threat of rising interest rates . This has some investors waiting for a better entry point before increasing exposure. Philip Blancato, chief market strategist at Osaic, said he’s interested in upping his exposure to Europe, but said he is holding off until there’s better clarity around how the region tackles AI policy. In essence, with markets increasingly concentrated in tech at a time when the broader market is showing signs of starting to break away, a thoughtful allocation to non-U.S. equities could be a prudent part of investors’ portfolios. “Markets are increasingly differentiating between the different players in the broader AI ecosystem,” Lebovitz said. “And so, I see what’s happening here as kind of a healthy development, and arguably providing a bit more life to this rally, as opposed to something that’s signaling that the end may be near.”
