Europe and China may be catching up, but US remains dominant force in stock markets

A rally in European and emerging market shares is fuelling speculation that the US’ decade-long stock market dominance is drawing to an end
But whether such a prediction comes to pass depends on how far the US dollar and global energy prices continue to fall

Nicholas Spiro

Published: 1:00am, 3 Feb 2023

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When it comes to global equity markets, the “America first” trade has been a smashing success. Since markets bottomed out in early 2009, following the global financial crash, the benchmark S&P 500 index has risen a staggering 502 per cent. However, the FTSE All-World ex US index – a gauge of the world’s stocks excluding US shares – has gained just 118 per cent.

The long period of American outperformance is attributable to several factors. One is the strength of the US dollar. Since the start of 2008, the dollar index – a measure of the value of the greenback against a basket of other major currencies – has surged 33 per cent.

A stronger dollar means higher debt servicing costs and tighter financial conditions for other countries. As the International Monetary Fund notes, half of all cross-border loans and international bonds are denominated in dollars. The private corporate sectors in emerging markets have particularly high levels of dollar-denominated debt.

Another key factor is the turmoil and sharp policy-induced sell-offs around the world. The euro-zone debt crisis in 2011-12, the popping of China’s stock market bubble in 2015, and Beijing’s regulatory crackdowns in 2020-21 have taken a heavy toll on sentiment towards Europe and developing economies.

Moreover, the US has benefited hugely from its technology-heavy equity markets. The weighting of the world’s tech giants – Amazon, Apple, Alphabet, Microsoft and Meta Platforms – in the S&P 500 reached a record high of 24 per cent in September 2020, powering a rally that was turbocharged by the Covid-19 pandemic.

Yet, over the past several months, US stocks have been left in the dust by a spectacular rally in European and emerging market shares. Since mid-October, the FTSE All-World ex US index has risen almost 25 per cent, compared with a 15 per cent increase for the S&P 500.

Screens show the indices for Dow Jones and S&P 500 stocks at the New York Stock Exchange, US, on January 9. Photo: AFP

Indeed, according to the findings of Bank of America’s latest global fund manager survey published on January 17, respondents cut their allocations to US stocks to the lowest level in 17 years. Instead, they increased their exposure to emerging markets and Europe, taking an overweight position in both regions which were out of favour with investors for many years.

This has fuelled speculation among investment strategists that the baton of regional leadership in stock markets is being passed from America to the rest of the world after a decade of US dominance.

Some of the stars are aligning for global stocks. First, the dollar has weakened sharply, falling more than 10 per cent since late September, mostly because of expectations that the Federal Reserve is winding down its interest-rate-hiking campaign. The greenback’s decline has been a boon for emerging markets. Yet, it also reflects the remarkable recovery in the euro, which accounts for a large share of the dollar index.

Europe’s single currency has risen 14.5 per cent since late September. A lot of this is down to cheaper energy. Wholesale gas prices, which rocketed following Russia’s invasion of Ukraine, have plummeted due to milder winter weather and are now lower than on the eve of the invasion. The euro-zone economy grew in the final quarter of last year, defying predictions of a deep recession.

Another crucial factor is the unexpectedly rapid reopening of China’s economy, which has allayed fears about a global recession and caused a rotation in stock markets out of the US and into emerging markets and Europe. The findings of Bank of America’s fund manager survey revealed that expectations for Chinese growth have surged to a 17-year high.

A man stands in front of a large screen showing stock exchange data in Shanghai, China, on January 3. Photo: EPA-EFE

The rout in tech stocks – which have suffered due to rising rates, mounting cost pressures and heavier scrutiny from investors – and, crucially, much cheaper valuations in Europe and emerging markets, have put US equities under further pressure. In a report published in December, JPMorgan noted that “the euro zone has never been this attractively priced [versus] the US”.

Yet, it is far too early to say whether US stocks are being dethroned by the rest of the world. There is still a lot that has to go right for Europe and emerging markets. The dollar has to keep weakening, gas prices need to fall further to ease pressure on industries that consume a lot of energy and investors need to tolerate risks that make many developing economies more volatile.

One of these risks is high leverage and questionable corporate governance. This week’s derailment of a US$2.4 billion share sale by Adani Enterprises, the flagship company of Indian tycoon Gautam Adani, due to allegations of accounting fraud and stock manipulation by New York-based short-selling firm Hindenburg Research has drawn attention to these vulnerabilities.

Get past China narrative to address poor nations’ debt crisis

While Adani’s conglomerate has strenuously denied the accusations, the decision to pull the offering risks exacerbating a loss of confidence in the group of listed Adani companies that were a key driver of the spectacular rally in Indian stocks, whose high valuations have long been a source of concern.

The “America first” trade in equity markets has unravelled. Yet, the outperformance of Europe and emerging markets has just begun and is fragile. Supplanting the US as the dominant force in stock markets for years to come still looks like an insurmountable challenge.

Nicholas Spiro is a partner at Lauressa Advisory