Life over there - How much longer can the US beat the rest of the world?

For many people, one of the most nerve-wracking experiences is to stand up and make a presentation to a large audience. If you find yourself in this position, the natural thing to do - like with most things in life – is to hop on Google and search for ‘tips on public speaking’. This will invariably lead you to a long list of gurus giving you their tuppence worth, but if you boil it down, near the top of most lists will be to ‘know your audience!’.

What might surprise you to hear is that the same principle should apply when the presentation is in the form of the written rather than the spoken word. Therefore, when you look at the title of this piece, knowing which prism your readers are looking through governs the answer they are going to have in their heads, long before they ever read your thoughts and opinions. Let me explain.

If you were a resident of the ‘land of the free and home of the brave’ – and not even a fully-fledged, card-carrying member of the MAGA (Make America Great Again) brigade – your answer to the question might well be “forever”, thereby justifying the long-term trend of US investors committing a paltry level of their investment accounts to markets outside the US. That said, when they do take a fancy to international markets, the effects, though short-term, can be pronounced given the quantum of money in the US savings and investment market.

Residents on this side of the pond will look at the question and list off multiple reasons why the winds of change should sweep through markets in the very near future. These could include valuation differentials, the duration of the current period of outperformance of the US, the strength of the US dollar, or more tangentially the growth versus value debate. The problem is that these same arguments could have and have been made many times before, with little evidence that they provided the catalyst for change.

When we look at the performance of the headline indices over the last decade, it doesn’t take a genius to recognise the direction and scale of the US dominance – in case you didn’t realise, just look at the graph below.

And if all we could invest in was a headline index, then trying to forecast when this trend will break is, at best, futile, and at worse an exercise in ‘hope over experience’. However, the good news is that we don’t just invest in the headline indices and instead have at our disposal a range of solutions spanning active managers and direct equity portfolios. This naturally leads to looking below the surface to see if anything else might be at work – and the results might just surprise you!

The table below shows the performance differential at a sector level between the US market and the rest of the world.

The red squares show the years when the US sector outperformed and the size of that relative performance, with the blue squares showing the years the US underperformed. The first thing that will surprise readers is the fact that there are any blue squares at all! But more interesting is the fact that although the US led from the front in 2023, seven of the eleven sectors underperformed their international peers in that year.

Of course, the sectors that outperformed in 2023 were those dominated by the ‘Mag 7’ stocks, and because of the size of these companies in market capitalisation terms, they drove the performance of the headline index and the relative outperformance of the US over international markets.

The other interesting point from the table is when we look at the performance so far in 2024. Given the fact that the ‘Mag 7’ trade has continued, albeit now even more focused on a handful of names, seeing these sectors in the US continue to outperform strongly is not that much of a surprise. But when you look at the relative performance of other sectors, we do not see the re-run of total US dominance that was evident in 2021. The performance of sectors like Financials, Energy, Industrials, Consumer Discretionary, and Healthcare are broadly similar in both regions.

Going back to the original question, if thirty years in the investment world has taught me anything, it’s that trying to pinpoint or time changes in market trends is about as successful as a chocolate teapot. But if we look at it in a wider (and potentially more beneficial) context, the question becomes what are some of the events that could reverse or re-enforce the trend?

The first, and most obvious, is a reverse or ending of the artificial intelligence (AI) euphoria that is gripping the market. This would have a significant impact on the headline indices in the US. But besides that, prolonged inflationary pressures in the US that cause the US Federal Reserve (Fed) to maintain interest rates higher for longer, particularly if this comes against the backdrop of deteriorating economic growth, would stress valuations in the US.

At this stage (incredible as this may be for many people), the outcome of the US presidential election is far from certain, and as a result what the world will look like post-November 2024 is unclear. While there may be little to differentiate the candidates from an economic policy perspective, vastly different foreign policy could have a significant impact on America’s position in a global context.

There is limited discussion on the financial/budgetary position of the US government – the size of the national debt is eye-watering, the servicing of that debt with higher interest rates is a serious drain on the finances, and the budget deficit is adding to the debt mountain every year. Coupled with the fact that the largest buyers of US debt over the last fifteen years (the Fed, China, and Japan) have all cooled their appetite for Uncle Sam’s IOU’s.

When this question is discussed, much of the debate focuses on how/what factors could deteriorate in the US. But the flip side is that things could improve everywhere else - economic growth could accelerate in China and/or Europe, or investor sentiment towards Asia and Emerging Markets could improve from the current low levels. Or perhaps currency weakness could improve earnings and therefore valuations of international markets. That said, the rest of the world is not without its issues too, not least of all, politics.

But at the end of it all, it’s clear that nobody knows how long the US outperformance will continue. And in that world, the best advice is to stick with your financial plan and make sure you have a diversified portfolio that is appropriate to your needs, goals, and aspirations.