US equities’ time at the top may be drawing to a close - Capital Economics
Asset Allocation

US equities’ time at the top may be drawing to a close

Asset Allocation Update
Written by Oliver Jones
Cancel X

We suspect that the outperformance of US equities relative to those of the rest of the developed world – a defining feature of 2019 and the past decade as a whole – will end.

  • We suspect that the outperformance of US equities relative to those of the rest of the developed world – a defining feature of 2019 and the past decade as a whole – will end.
  • The MSCI USA Index has returned about 13% a year on average since the end of 2009, compared to just 5% (in US dollar terms) for its World Ex USA Index of equities in the rest of the developed world. To explain why that gap has been so large, Chart 1 breaks down the returns from the two indices into constituent parts.
  • As the Chart shows, dividend payments have actually been slightly greater in the World Ex USA Index, but that has been more than offset by faster growth in earnings per share (EPS) in the USA Index, as well as a more favourable shift in valuations (as measured by price/earnings ratios) in the latter. The strength of the greenback has been an additional drag on the dollar returns from the World Ex USA Index.
  • Consensus EPS forecasts compiled by Bloomberg suggest that investors expect EPS growth to remain several percentage points faster in the US than elsewhere. But there are a few reasons to be sceptical, even if economic performance remains a little better in the US than the rest of the developed world.
  • First, declining effective tax rates have been an especially big kicker to EPS in the US. But President Trump’s tax reform, which we estimate increased EPS in the MSCI USA Index by more than 10%, was probably a one-off. Second, EPS-boosting share buybacks have also been particularly prevalent in the US – but the pace of buybacks has fallen this year, and the political pressure to reduce them seems to be building.
  • Third, other political developments in the US could end up weighing on EPS there, but not elsewhere. Elizabeth Warren, the leading Democratic contender for the 2020 election, has pledged to break up the “big tech” firms that have contributed disproportionately to EPS growth in the US. She and other Democrats also plan to raise US corporate taxes, and to reorganise health care, another large sector in which EPS has surged in the US. Fourth, there are question marks over why the earnings reported by US companies have outstripped macroeconomic measures of profits calculated by the BEA to a historically-unusual extent.
  • Meanwhile, the wedge between the valuations of the USA and World Ex USA indices now looks very large. The price/earnings ratio of the MSCI World Ex USA Index is about 20% lower than that of the MSCI USA Index on either a trailing or a forward basis. (See Chart 2.) This “discount” has only ever been much larger for a few months, and does not go away if you adjust for the sectoral compositions of the indices. With all of that in mind, it seems unlikely that it will continue to grow as it has done over the past decade.
  • Finally, although we think that the dollar will strengthen a bit further against other major currencies in the next few months, we suspect that it will pull back from around a multi-decade high in 2020-21.

Chart 1: Contributions To Average Annual
USD Returns Of MSCI Indices Since End-2009 (pp)

Chart 2: Percentage Gap Between Price/Earnings Ratios Of MSCI USA & World Ex. USA Indices

Sources: Bloomberg, CE

Sources: Bloomberg, CE


Oliver Jones, Senior Markets Economist, +44 20 7811 3912, oliver.jones@capitaleconomics.com