The US stock market has outperformed peers since the global financial crisis, leading to American equities currently accounting for almost two-thirds of global benchmarks, up from less than a half a decade ago. Over the last 12 months the relative performance has become increasingly stark, driven by the clamour to own mega-cap technology companies widely deemed to be best placed to cash in on the Artificial Intelligence (AI) hype.
James Hughes and I recently had the pleasure of being joined on our Taking Stock podcast by Anthony Kingsley, Chief Investment Officer at Findlay Park Partners and co-manager of the firm’s American fund.
The firm’s performance — a compounded return after fees of just over 12% per annum since its 1998 inception, equating to a 20x total return vs around 6x for comparable benchmarks - speaks for Anthony’s credentials as a US investor. His knowledge and experience make him ideally placed to opine on the reasons for the US equity market juggernaut of the last 15 years, and, more importantly to investors, also to discuss whether it can continue.
US equity market outperformance vs the rest of the world
Source: FactSet, 1 February 2024
In a nutshell, American exceptionalism in stock markets can be attributed to the Lollapalooza effect, famously coined by long-time Berkshire Hathaway vice chairman Charlie Munger. Simply put, the phenomenon occurs when different attitudes and desires converge to drive people in the same direction. The reasons for the outperformance can be split into two broad categories; longstanding factors and more recent positive developments.
US stocks outperformed in the second half of the 90s and since 2011. They underperformed in the 00s.
Source: FactSet, 1 February 2024
Enduring factors:
- Economy: largest in the world, currently 26% of global GDP. Highest GDP per capita, except for a handful of sparsely populated countries, each representing less than 1% of global GDP.
- World-leading markets: largest, broadest and most liquid financial markets. Not only equity and debt markets but also private equity and venture capital for earlier stages of growing a business. Many of the largest US companies were start ups 20-30 years ago — Alphabet, Amazon, Meta (Facebook), Nvidia, Tesla etc.
- Demographics: Favourable compared to all other major countries, except India. 300m+ customers in one country with no language barriers.
- Culture: Strong, deep-rooted culture of innovation and entrepreneurship — and successes being rewarded. Known for shareholder friendliness, unlike Japan and China.
Positive developments:
- Reshoring/Onshoring: The US is a relatively self-sufficient country, particularly with energy and food. A look at corporate revenue origin highlights this with 60% of revenue domestic for a US large-cap stock benchmark, in contrast to around 25% for the UK.
- Independence: Shifting from a sizable importer to an exporter of oil, has become an increasingly positive development. Shorter supply chains when abroad, often through Mexico. Much less reliance on global trade than many peers, as reflected in the recent Red Sea issues being not as impactful.
- Technology companies: The aforementioned members of the Magnificent Seven, together with Apple and Microsoft, mean that the US can claim practically all the largest technology firms.
US stocks look expensive on simple valuation measures
Source: FactSet, 1 February 2024
On the face of it, US stocks are more expensive than the rest of the world, with the premium close to as wide as it has been for 20 years. However, this can largely be explained by greater confidence on future earnings and return on equity — a continuation of recent trends that have developed due in no small part to the prominence of mega-cap tech companies in the US.
US earnings growth has outstripped the rest of the world
Source: FactSet, 1 February 2024
As has, return on equity:
Source: FactSet, 1 February 2024
Can it continue?
The big question for investors going forward is can the US stock market continue to outperform? The short answer is yes. The US economy has, thus far, coped far better than its peers with the rapid increase in interest rates to combat inflation. In 2023, US GDP rose by 3.1%, comfortably above the 0.5% seen in the Eurozone or -0.1% for the UK. Concerns remain around the strength of regional banks and commercial real estate but, as we approach the one year anniversary of the collapse of Silicon Valley Bank, Signature Bank and First Republic Bank, these fears remain contained.
The US is ahead of the UK and Eurozone in its fight against inflation, benefitting from less dependence on energy imports. Recent strength in the economic data suggests that the markets have gotten a bit ahead of themselves in expecting the Federal Reserve to imminently begin cutting interest rates, but that is not necessarily a bad thing. Should economic data weaken, the central bank is ready, waiting and able to provide support.
Relative valuations are a go-to argument for those believing the end is nigh for US equity outperformance, but there is a strong case to be made that these premiums are justified. The mega cap tech stocks are placed front and centre of the clamour for AI and have demonstrated a remarkable flexibility for such large corporations in responding swiftly to changing circumstances — Meta’s cost-cutting measures and return of focus to its core propositions being a case in point.
If the Magnificent Seven stocks are excluded from US indices, then much of the valuation gap with peers is taken away. Put another way, most US stocks are not that expensive compared to UK or Eurozone equivalents. Enduring positive factors, such as demographics, culture and market infrastructure make for a relatively favourable environment for US stocks, while recent developments in the onshoring/reshoring trend and volatile energy and food prices also benefit the US more than most.
This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination marketing communications. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it
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