One of the most consistent themes in financial markets over the past 15 years has been the outperformance of US equities. A dollar invested in the S&P 500 at the low of the financial crisis in 2009 would now be worth over $10, more than double the return from European equities and around three times the return from UK, emerging markets or Chinese equities. An allocation of 100% US equities would have been difficult to beat. Why have US equities been so successful and will the trend continue?
Chart 1: US equity market’s runaway success since the GFC
S&P 500, MSCI Europe, MSCI Japan, MSCI United Kingdom, MSCI China, MSCI Emerging Markets total return indices in USD rebased to 100 on 09/03/2029. Source: LSEG Datastream, Fidelity International, September 2024.
A big part of the story behind US exceptionalism over the past 15 years has been the stellar performance of the technology sector. The US is home to the majority of the largest and fastest growing tech companies in the world and this has helped propel US equity markets in the information age. Tech has fantastic margins and, even though it has often looked expensive on valuations measures, earnings growth has always been there to deliver returns.
An overlapping reason is that the US also features a concentrated group of idiosyncratic companies, loosely known as the Magnificent 7, that have been particularly successful in protecting their competitive moats. These companies have come to dominate and even monopolise their respective areas of business and managed to avoid a high degree of direct competition with each other. They have also been quick to acquire smaller competitors that might threaten their competitive advantage.
The strength of the US dollar is another contributing factor, boosting the returns of dollar denominated assets compared to those in other currencies. The US also has high productivity compared to other regions. Finally, the 2017 tax cuts provided a one-off boost to the US stock market.
Can US exceptionalism continue?
There’s no compelling reason why the dominance of the US equity market cannot continue for some time. Granted, the tax cuts and dollar appreciation are unlikely to be repeated. However the US has better demographics than Europe or China and hence has a long-term edge over those regions, while its better productivity keeps wages and therefore consumption high.
Furthermore, the US is the largest oil and gas producer in the world, which has insulated it from recent energy market shocks and should do so again in future. The US also remains a hotbed of innovation, while Europe tends to be more bureaucratic, which can stifle innovation. The longer-term beneficiaries of the AI revolution remain to be determined, but US companies currently look better poised to capitalise than those of other regions.
What could dethrone the US?
The chief caveat to this is that none of the above reasons in favour of continued US exceptionalism are particularly secret, meaning a lot of it should already be reflected in the price. US equity valuations are already relatively high, especially compared to other regions, so there is scope for some disappointment to creep in if the US doesn’t live up to the high expectations.
US valuations began to drift higher than other regions in 2017. For each dollar of expected earnings, investors now pay over $20 in the US, compared to only $15 in Japan, $14 in Europe, and less than $10 in China. Higher valuations today tend to reduce long-term returns.
