There is one distinct financial trend that has stood out clearly for more than a decade: U.S. equities have been the best place for investors to park their money.
The dominance of dazzling technology companies and U.S. multinationals has seen Wall Street comprehensively outperform the rest of the world. But that allure faded in recent months as investors focused on a robust global economic recovery that benefits a broader range of companies and equity markets.
The FTSE All World Index, excluding the S&P 500, has risen by a quarter since November, beating a gain of one-fifth for the U.S. benchmark.
“Investors are very confident about global reflation over the coming 12 months, including further improvements in business confidence and corporate earnings,” said David Bowers, managing director at Absolute Strategy Research Ltd. in London, after the release of the firm’s latest quarterly survey of global asset allocators.
Upgrades about the scale of the unfolding economic recovery keep on coming. The latest fiscal package from Washington compelled the Organization for Economic Co-operation and Development to raise its global economy growth forecast to 5.6 per cent for 2021 from 4.2 per cent late last year.
Even stronger growth is expected in the U.S. Last week, U.S. Federal Reserve Board officials upped their U.S. median growth forecast for 2021 to 6.5 per cent from a previous estimate of 4.2 per cent.
Jerome Powell, the U.S. central bank’s chair, maintained that it would allow the economy to run hot and would not look at tightening policy until officials were convinced that inflation was holding above 2 per cent and the jobs market was very tight.
The equity market fallout from the comments followed the recent trend of a rotation of investor positioning. The U.S. benchmark S&P 500 initially set a fresh record and global shares rallied, supported by a shift into economically-sensitive sectors that include energy, banking, materials and industrials.
Technology sector shares were weaker, with their lofty valuations making them look less appealing when a global economic recovery is gathering pace. A rising 10-year interest rate reduces the expected value of future cash flows, especially the more speculative prospects that are full of promise but with actual profits some way off.
Given Wall Street’s hefty weighting of technology compared with the rest of the world, a combination of strong growth and an orderly rise in bond market rates might be expected to extend the current equity market rotation.
However, global investors appear to be keeping the faith in their home market. Mr. Bowers says a surprise finding from his firm’s survey was the “reluctance among investors to underweight U.S. equities within a global portfolio.”
He adds that expectations of Wall Street beating the rest of the world over the next 12 months are not far from being a “coin toss” at 46 per cent. Mr. Bowers says investors were mindful that U.S. stimulus and the rollout of vaccinations was running well ahead of Europe at the moment.
Another factor is the resiliency of the U.S. dollar in the past month, boosted by higher long-term interest rates. That makes it more attractive to hold U.S. dollar assets. In contrast, Wall Street typically lags behind the rest of the world when the reserve currency broadly weakens.
A weaker U.S. currency boosts global growth and corporate earnings by reducing financing costs. Rising local currencies bolster returns for global investors holding non-U.S. equities, particularly in emerging markets.
Citi’s global asset-allocation team wrote last week that it had increased its recommended portfolio weightings toward the U.S. and Japan and away from Europe and emerging markets.
The bank cited a “materially higher U.S. growth outlook” from stimulus and added that dollar strength “is usually quite negative for emerging markets, across all asset classes.”
A firmer dollar tends to boost Japanese corporate earnings by boosting the value of export sales when translated back to yen.
Chris Watling, founder of Longview Economics Ltd. in London, argues that worries of a stronger U.S. dollar undermining the case for shifting into global equities are misplaced.
“U.S. share market underperformance looks well established,” he says, and that reflects a shift toward an extended period of U.S. dollar weakness. “When the U.S. consumer gets going, their demand for imports benefits global exporters in Asia, parts of Europe and among commodity producers.”
But what might keep investors pointing toward Wall Street is a strong cycle of earnings growth, including those of large tech names this year, that vindicates high valuations.
“Valuations are higher and on average the fundamentals of large U.S. companies are better than what you find elsewhere,” says Tony Despirito, managing director and chief investment officer of U.S. fundamental equities at BlackRock Inc. in New York.
One-quarter of his equity dividend fund are investments in global large companies.
“The U.S. has led global stimulus efforts and it does suggest a much stronger recovery for the economy,” Mr. Despirito says.
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