Years of U.S. stock outperformance are finally cresting and their share of the global pie is likely to normalize from here.
The U.S. slice of the multi-trillion dollar global equity market remains high by historical standards but is set to fall as wildly inflated Big Tech valuations reset, the dollar retreats and other regions play catch-up alongside a shift in sector leadership.
The stellar start to the year on Wall Street has been extraordinary - the best January for the Nasdaq since 2001. But it still lags many leading European and Asian benchmarks while, by many measures, U.S. valuations remain both absolutely and relatively stretched.
With investors already positioned for a shift this year away from U.S. stocks to beaten-down Europe and China, even a return of U.S. stocks to their long-run average share of global market cap would see Wall Street lose ground to its peers this year.
According to figures from the World Federation of Exchanges, U.S. equity market cap accounted for 41.0% of the world total last year. That was just below the previous year’s 42.0%, which was the highest since 2003.
Based on WFE data, U.S. market share has averaged 38.3% since 2000. Excluding the three years from 2000 to 2002 - when the U.S. share ranged between 49.1% and 52.4% as the dot-com bubble peaked and burst - the average is 36.5%.
Meanwhile, global equity market data provider MSCI estimates that U.S. market cap as a share of the global total hit a record high around 62% in 2021. It has dipped a bit since, but is still a historically high 60%, well above the early 2000s peak around 55%.
While the exact numbers may differ, the picture is strikingly similar: the trend of increasing U.S. dominance in recent years is ripe for reversal.
“When one country dominates a global portfolio to such an extent, that is something worth doing further research on,” said Raina Oberoi, global head of equity solutions research at MSCI. “Market cap proportions and valuations alone do not signal bubbles, but they can be warning signs.”
THAT SHRINKING FEELING
According to Datastream, global market cap is around $85 trillion, down from a peak of just under $100 trillion in late 2021. WFE data show it ended last year around $100 trillion, down from a peak around $125 trillion a year earlier.
Not only is the U.S. share of that pie high by historical standards, U.S. valuations are historically high too.
Calculations from MSCI’s Oberoi and her colleagues show that U.S. stocks are around 1.5 standard deviations more expensive than global stocks ex-U.S., close to the recent high of 2.0 times. The last time they were this expensive was in early 2002, just as the Nasdaq tech bubble was bursting.
They estimate that over the 2008-2021 period, U.S. stocks broadly outperformed the rest of the world ex-U.S. by around five times. This length and depth of U.S. exceptionalism is unlikely to be repeated.
Mark Haefele, global wealth management chief investment officer at UBS, reckons U.S. stocks are about 40% more expensive than European and emerging market stocks. He bases this on the S&P 500 index trading about 17.7 times consensus estimates for 2023 earnings, compared with around 12.5 times for the MSCI Europe and EM indices.
This means U.S. stocks are at one of their most expensive levels in 15 years. Add to that the fact that Wall Street is heavily weighted towards tech, which is more sensitive to high interest rates and slower growth, Haefele is advising clients to broaden their international exposure.
“We expect international stocks to deliver a superior return to the S&P 500 over the next several market cycles,” he wrote in a note on Jan. 25.
Haefele didn’t give specific estimates, but it would be surprising if he is gloomier on Wall Street than analysts at research firm Topdown Charts. They expect U.S. equity real returns over the next five to 10 years of around 0.5%, compared with around 9% for developed markets ex-U.S. and 10% for emerging markets.
Shrinking the U.S. slice of the global market cap pie will take time, but there are indications that investors’ U.S. equity holdings have already been cut significantly. Indeed, money managers may now be significantly under-exposed to U.S. stocks.
For most of the four-year period encompassing 2018-2021, the most crowded trade among fund managers responding to monthly Bank of America surveys was some iteration of long U.S. equities, usually tech stocks.
But the last poll in January showed that investors’ exposure to U.S. equities is historically low, with fund managers now the most underweight U.S. stocks since 2005.
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