American Exceptionalism May Be Ending—at Least in Stocks
The S&P 500’s dominance over the MSCI All Country World Index has looked shaky in recent weeks
Recent choppy trading in U.S. shares has revived a yearslong debate: Are the best days of the bull market over, and should investors pivot to cheaper stocks overseas?
The S&P 500 is beating the MSCI All Country World Index, excluding U.S. stocks, by about 11% this year in total return terms, a measure which takes dividends into account. But that dominance has looked shaky in recent weeks.
Any sustained shift away from the U.S. by foreign investors would be especially welcome in developing countries, whose companies could be able to access cheaper and more plentiful equity capital. And it would also come as a relief to investors focused on these riskier markets, who have not enjoyed outsize returns to match.
It could also remove an important support for the U.S. market. The near-constant outperformance of American equities during the past decade has raised their international popularity. The most recent data available, for the first quarter of this year, shows foreigners owned nearly 15.3% of U.S. shares, up from 11% in early 2008.
“We do not own U.S. domestic stocks, as the market is significantly overvalued” compared with other countries, said Jacob Mitchell, portfolio manager of the Australia-based Antipodes Global Fund, which had around $4.59 billion in assets under management at the end of October. “We would go as far as saying this area of the market is becoming an interesting place to short.”
Mr. Mitchell said he was considering shorting, or betting against, stocks closely tied to the health of the U.S. economy, like retailers and transportation companies, without naming specific targets. In contrast, in developing Asia and Western Europe he already holds more stocks exposed to the strength of their domestic economies.
As the fourth quarter of the year began, over 60% of the fund’s “long” equity exposure was to Asian and European stocks. Long positions can be traditional investment holdings or other bets that benefit when a company’s shares go up in value.
Morgan Stanley researchers recently moved to an underweight position on U.S. equities, recommending clients hold smaller positions than the global benchmarks they track. In contrast, the bank’s team is now overweight shares in Japan and emerging markets, highlighting opportunities in financial and commodity stocks and India, Brazil, Thailand and Indonesia.
Equities outside the U.S. are “exceptionally cheap” compared with U.S. stocks, according to the bank’s strategists. They say a weaker dollar, more stimulative economic policy from Beijing and a possible detente on trade could support non-U. S. stocks in 2019.
In recent years, optimistic investors have bid up U.S. stocks faster than their profits have been rising. That has led to rich valuations—a concern often expressed by investors trying to decide how to invest in the year ahead. In September, U.S. shares were priced at 17.4 times expected earnings in the next 12 months, compared with just 12.95 times earnings for stocks overseas, according to FactSet indexes which cover tens of thousands of listed companies. That gap has shrunk since, but remains wide relative to recent decades.
It isn’t just the dominance of highly valued tech giants like Facebook and Apple that make the U.S. market more expensive. Most sectors are pricier than elsewhere, FactSet indexes show. Industrial companies, such as Halliburton Co. and Schlumberger Ltd. , fetch the greatest premium relative to foreign rivals, with valuations around 50% higher.
Still, investors have been burned in the past by moving out of the U.S. and into markets overseas. In dollar terms, an investment in the S&P 500 a decade ago would have returned around 278% to investors. The same investment in the MSCI All Country World Index, excluding U.S. stocks, would have made its buyer a return of 120%.
Arno Lawrenz, global investment strategist at Ashburton Investments, said the U.S. “earnings outlook remains superior compared with most other regions.”
The company’s Global Growth Fund raised its holdings of U.S. equity to 34.3% of the portfolio, up 4.5% from September, and trimmed its exposure to Europe, Japan, the rest of Asia and emerging markets more broadly. Mr. Lawrenz said Ashburton was still wary of the most highly valued U.S. sectors, such as information technology.
Other investors have rotated their holdings into less expensive U.S. stocks. Daniel White, a fund manager at M&G focused on North American stocks, owns a small position in Google parent Alphabet Inc. but otherwise holds no shares in Facebook, Amazon, Apple or Netflix, the rest of the FAANG grouping. Instead, Mr. White is investing in cheaper hardware and semiconductor stocks.