Why US Stocks Remain the Brawniest in the World

Art by Brian Scagnelli

Despite last week’s stock wipe-out, the heavyweight US exchanges continue to lord it over all the world’s major bourses. Thanks to America’s heft as the world’s largest economy and the prominence of its monster tech firms, the nation’s stocks have outperformed the rest of planet’s.

“US companies just dominate the global scene,” said Doug Foreman, chief investment officer of Kayne Anderson Rudnick. Their earnings are up three- or fourfold following the recession, he added, while Europe’s “have gone nowhere since 2008.” Ditto Japan. Emerging markets have had their moments of superior stock gains, like in the century’s first decade, yet these always have faded.

While economic growth and stock appreciation are closely linked, things work out differently in different places. China’s growth rate in gross domestic product may be three times that of the US, but the more vibrant and larger American stock markets have stayed far ahead of Chinese equities and others’ for the past decade. With only 4.3% of the world’s population, the US as of January had more than half of the world’s market value (54.5%), weighing in at roughly $46 trillion, more than six times that of the next largest stock market, Japan.

Helping US stocks is that foreign investors see this country as a haven, thanks to its robust capitalism, rule of law, and immense size. That has attracted torrents of outside money to its individual stocks, as well as to mutual funds, exchange-traded funds, real estate, bonds, and other investments. Partly as a result, the dollar has climbed. After a brief dip at the outset of the year, the virus crisis has propelled the buck aloft once again.

Although no one can know how badly the coronavirus will harm GDP expansions and share prices around the world, odds are that US stocks will lead the pack for some time going forward. The best-case scenario is that the contagion burns out like previous ones “and we take a quarter or two to get back” to normal, said Rich Sega, global chief investment strategist at Conning. Coronavirus’s trajectory, though, has a lot of unknowns, which could postpone that happy day, he said. “Like, can you get the virus a second time?”

Of course, aside from the virus, the domestic economy does have a gaggle of weaknesses that could eventually thwart further rises in GDP and US stocks, such as high stock valuations, federal deficits, and tempestuous politics. Right now, however, these are non-issues for investors.

Until very recently, US stocks enjoyed an enormous surge, with the S&P 500 advancing 31.3% in 2019, and that big rally rolled into this year—until it didn’t, with news of the virus’ global spread applying the brakes. It remains to be seen how durable Monday’s snapback of 4.6% is.

The larger point is that American stocks, which lost 8.6% for the year through last Friday, haven’t suffered as much as their counterparts.

Among large economies, the biggest loser is Britain, whose stocks were off 14% in 2020 as of last week, no doubt harmed by ongoing uncertainty over Brexit. London’s negotiations with the European Union over how to rearrange trading protocols are on shaky footing. Only one other economic power center has done better than the US: That’s China, with equities down just 1.7% this year. As China is ground zero for the virus, that seems paradoxical, and likely is owing to the Beijing regime’s massive stimulus to offset the epidemic’s malign economic impact.

Over a longer span, five years, US preeminence over others is even more clear, with American stocks averaging 9.2% yearly. The closest competitor was China, up 6.2%, fitting because of its rapid GDP growth and status as the world’s second-largest economy. And that’s in spite of the US-China trade war, which is on hold pending negotiations

American Exceptionalism

The chief engine that has pushed US stocks aloft is tech. Removing FAANG stocks—Facebook, Amazon, Apple, Netflix, and Google parent Alphabet—from the S&P 500 would make the “index returns look much less impressive over the past decade,” observed a commentary from Capital Group, the sponsor of American Funds.

According to Yardeni Research, without the FANGs (Apple is left out here), the S&P would have risen only a third as high since 2013, when it finally broke past its pre-recession peak. Indeed, this high-flying group has mostly stayed in the black in 2020, in spite of last week’s horror show.

Just two of them were down this year as of Friday, Facebook (the target of politicians who think it violates privacy and enables extreme polemicists) by 8.2% and Apple (whose primary product, the iPhone, is made in largely shuttered China) by 6.6%. But over 12 months, Facebook and Apple are still ahead, up 19.2% and 59.6%, respectively.

Measuring index stock sectors worldwide, Capital Group’s report concluded, the S&P 500 had 70% in information technology for the sector, with a mere 30% for non-US indexes. The situation was reversed for slower-growing categories—financial services make up 68% for foreign indexes, and 32% for the S&P. Only a handful of European tech stocks, including ASML and Temenos, have valuations equivalent to the US tech giants, the report found.

The American entrepreneurial instinct finds its highest expression in tech startups, which explains the higher market performance, argued Cameron Brandt, director of research at data provider EPFR. “The US remains more dynamic than Europe and Japan,” he said. He noted how many large American companies are in top positions internationally, in particular the FAANGs.

The US Contra Mundo

Business culture varies from country to country. “The Chinese are more capitalist than we are, and they work seven days a week,” contended Kayne Anderson Rudnick’s Foreman. “The Europeans admire poets and artists, so you don’t see a Warren Buffett or a Bill Gates in Europe.”

There’s no doubt that, except for China, the US economy has an edge when it comes to growth over other major developed nations. (A debate roils over whether China still should be classified as an emerging market.) Last year, US GDP increased 2.3%, handily surpassing Britain at 1.4%, Germany at 0.6%, and Japan at 1.9%. Of those, the surprise laggard was Germany, whose industrial exports, most prominently from its auto segment, have ebbed.

China’s GDP in 2019 climbed 6.1%, not the old 10%-plus of earlier days, when it was a fast-growing tyro, yet still pretty darn decent relative to the developed economies. While the trade war hasn’t helped the Chinese economy, the contagion, which has shuttered factories and confined millions to their homes, may well whittle that GDP number further. In this year’s first quarter, said Stuart Katz, CEO of Robertson Stephens Wealth Management, “I wouldn’t be amazed if it went to 4.5%” annually.

Until the 21^st century, other than in recession years, US economic growth regularly exceeded 4% yearly. In this century, the best showings were in 2000 at 4.1% and 2004 at 3.8%, per Statista figures. Aside from these two, GDP growth has hovered around 2% per year. Numerous explanations exist for what’s called “secular stagnation,” ranging from an aging population to a dearth of breakthrough science. And this condition is shared throughout the developed world.

Emerging markets are the place to find effervescent growth, other than when commodity prices dip, as many EMs depend on raw material exports. India, for instance, expanded 5.6% last year, and its GDP is one-eighth that of the United States. Still, EM stocks can be erratic: Thus far this year, the sub-continent’s stock market is off 8.4% and, annually over five years, up a mere 0.3%.  

What Could Go Wrong for the Equity Colossus?

US investors tend to stick to stocks on their own shores. To Robertson Stephens’ Katz, this attitude is reminiscent of Dorothy in The Wizard of Oz, saying, “There’s no place like home.”  He condemns such thinking as “a bias, not a strategy,” and urges domestic investors to look abroad for diversification and potential outperformance.

As of the end of 2019, the high valuation of American stocks (S&P 500 forward-projected price/earnings ratio: 17.8) was remarkable compared to the P/Es in developed nations outside the US (14.4), and emerging market countries (12.3), Capital Group stats indicate.

Detractors within and outside the US have been predicting its decline for decades, without success. That doesn’t mean such a swan dive never will happen. But over the next few years, the home of the No. 1 economy and the apex of capital markets faces some challenges that could at least restrict investment returns.

Let’s run through them. The trade war, on hold for now, could resume, harming US farmers and other exporters. The US tech industry is under fire politically and may face antitrust enforcement. Chronically huge federal deficits may erode the patience of Treasury bond buyers, here and abroad, leading to higher costs of US borrowing and possible crowding out corporate debt issuance (this has been oft-feared but never has it actually occurred, yet). And then comes political risk. The nation is fiercely divided by ideology, to the point that effective governing may break down.

“We’ve gone for longer than a decade with the US leading the developed world in equities,” said Scott Colyer, CEO of Advisors Asset Management. At some point, “a reversion will come.”

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