Why U.S. stocks are off to the worst start since 1995*

US vs. Global Stock Performance – Early 2024 & Beyond

Key Concepts:

• Multiple Expansion: An increase in the price-to-earnings (P/E) ratio of stocks, driving returns without corresponding earnings growth.
• Geopolitical Risk Premium: The additional risk and potential lower returns investors demand due to political instability or uncertainty.
• Valuation Premium: The extent to which a market or stock is priced higher relative to its earnings or other fundamental metrics compared to other markets or stocks.
• XUS: An index representing global stocks excluding the US.
• Secular Growth: Long-term growth trends driven by fundamental shifts in the economy or technology.
• Critical Minerals: Elements essential for modern technologies, often subject to supply chain concerns.

1. US Stock Market Underperformance – A Historical Context

US stocks are experiencing their worst start to the year since 1995, contrasting sharply with the performance of global markets. Data from Goldman Sachs confirms this trend, with global markets (represented by the XUS index) up roughly 8% year-to-date while the US market is flat to slightly down. Over the past year, this divergence is even more pronounced: the US is up 11% while the rest of the world has risen approximately 30%. This represents a significant performance gap not seen in a long time.

2. Factors Contributing to the Disparity

Three primary factors are driving this divergence:

• Valuation: US stocks are becoming increasingly expensive, trading at a price-to-earnings (P/E) premium of roughly 40% over the rest of the world, according to Apollo’s Torston Slok. This means investors are paying a significantly higher price for each dollar of earnings in US stocks.
• Concentration: The US market is heavily weighted towards technology stocks, making it reliant on the success of the “AI trade.” Diversification is becoming a priority for investors, and international equities offer a broader range of sectors.
• Geopolitical Risk: Ongoing geopolitical concerns – including issues related to Greenland, Venezuela, and the previous administration’s tariff policies – contribute to a risk premium associated with US investments.

3. Relative Performance & Potential Upside in International Markets

While US markets have enjoyed consistent strong performance, some international markets, particularly Europe, may have greater upside potential. This is because they are coming from a lower starting point and have experienced less growth in recent years. Investors are increasingly considering increasing their asset allocation abroad, with Japan frequently cited as a particularly attractive destination.

4. US-Japan Investment Agreement & Strategic Realignment

A recent US-Japan trade agreement includes a $36 billion initial investment from Japan into the US, part of a larger $550 billion deal. This investment is focused on the energy sector, specifically a 9-gigawatt natural gas plant in Ohio, capitalizing on the state’s growing data center hub status and the demand for power driven by AI. This agreement represents a strategic realignment, shifting capital into the US, de-risking from China, and securing access to US critical minerals and oil/gas resources. The agreement also includes reduced tariffs on automobiles, benefiting the Japanese auto industry (Lexus, Toyota, Nissan).

5. Concerns Regarding Sustainability of International Outperformance

Despite the recent outperformance of international markets, concerns remain about its sustainability. A significant portion (90% in Europe in 2023) of the returns in non-US markets has been driven by multiple expansion – an increase in valuations – rather than fundamental earnings growth. The speaker argues that returns driven by earnings are more sustainable at this stage of the economic cycle. US earnings growth is currently outpacing the rest of the world.

6. Fundamental Differences & Quality Disparities

The speaker emphasizes that the fundamentals of many international markets do not match those of the US. US companies generally have stronger balance sheets, higher cash flow, better earnings margins, and greater growth opportunities, particularly in the technology and communications sectors. While some high-quality European companies trade at comparable multiples to their US peers, lower-quality companies (particularly banks) trade at discounts, which is considered justified due to their structural disadvantages.

7. Emerging Asia as a Bright Spot

Emerging Asia, particularly Korea and Taiwan, is highlighted as a region with strong earnings growth and impressive total returns. However, this performance is driven by a single narrative and may be less diversified. The speaker’s portfolio maintains a significant overweight position in this region.

8. Currency Adjustment & Earnings Growth – Key Metrics to Watch

Currency adjustments played a role in the 2023 rally, and their impact will be closely monitored. The key question is whether earnings growth can support the recent gains in international markets. The speaker notes that US earnings growth is meaningfully outpacing the rest of the world.

Notable Quote:

“For the rest of the world to continue to outperform the US on a total return basis we’re going to have to have some fundamental followthrough. And frankly that’s not what we’re getting quite yet.” – Speaker, referencing the need for earnings growth to justify international market valuations.

Conclusion:

The early 2024 performance divergence between US and global stocks is driven by valuation, concentration, and geopolitical factors. While international markets have outperformed, concerns remain about the sustainability of this trend, as much of the gains are attributable to multiple expansion rather than fundamental earnings growth. Japan is emerging as a key investment destination, and the US-Japan trade agreement signifies a strategic realignment. Investors are advised to closely monitor earnings growth and currency adjustments to assess the long-term viability of international market outperformance. The speaker suggests that while pockets of strength exist, the broad-based fundamental support for international markets remains questionable compared to the US.