The US is still outperforming its competitors in global markets, but a rising dollar and the prospect of Donald Trump being re-elected could change that

On Tuesday the euro zone, which has supplanted China as the main source of concern about the health of the global economy, received a much-needed boost following the publication of data that showed the bloc expanded by 0.4 per cent quarter on quarter in the first three months of this year. 

Not only was the euro-zone’s growth rate twice the pace in the final quarter of last year, it stemmed partly from an unexpected rebound in Italy – the most vulnerable of Europe’s largest economies – which grew by a stronger-than-expected 0.2 per cent, having slipped back into recession at the end of last year.

In China, meanwhile, the profits of industrial firms grew almost 14 per cent in March, following four straight months of contraction. Manufacturing output, while having slowed last month, is also back in expansion territory as a series of stimulus measures enacted since last summer start to bear fruit.

Yet, in financial markets, it is America that is outshining the rest of the world, leading to a revival of last year’s “divergence trade” in which international investors bet on the continued outperformance of US assets relative to those in Europe and emerging markets.

Since the beginning of this year, the Nasdaq Composite, America’s technology-heavy equity index, has surged more than 21 per cent. On Monday, the index reached a new all-time high. On Tuesday, the benchmark S&P 500 index, which is up 16.5 per cent this year, hit its own fresh record high.

If US stocks are excluded, global equities have risen by a less spectacular 12 per cent this year, on a par with the increase in emerging market shares, data from MSCI shows. According to a report published by JPMorgan last Friday, US equity indices account for three of the four best performing asset classes this year.

The outperformance of US stocks is mainly attributable to America’s buoyant economy, particularly when compared with the tepid growth in the euro zone.

In the first quarter of this year, the US expanded by 3.2 per cent year on year. Europe’s single currency area, by contrast, grew by just 1.2 per cent.

Moreover, growth in the euro zone remained weak in April, with the bloc expanding at its slowest pace since 2014, preliminary survey data published by IHS Markit revealed.

America’s economy is also benefiting from looser-than-anticipated monetary policy following the Federal Reserve’s unexpected decision earlier this year to put its interest-rate-hiking campaign on hold.

Bond markets are even pricing in a rate cut by the end of this year, despite America’s robust growth rate last quarter. With inflation standing comfortably below the Fed’s 2 per cent target, the US is in a “Goldilocks” environment, in which growth is neither too hot nor too cold.

To be sure, America has its fair share of problems. The uncertainty surrounding the trade war has contributed to a slowdown in investment, particularly in America’s agricultural sector as farmers grapple with the fallout from tariffs.

More importantly, President Donald Trump’s protectionist policies have severely undermined America’s reputation for competent policymaking, as have his aggressive tax cuts, which have saddled the US with the highest fiscal deficits on record outside wars and recessions, according to the Committee for a Responsible Federal Budget, a US bipartisan group.

Yet despite these disadvantages, America is better placed to attract capital flows than the other main regions of the world, a comparative advantage that has become more pronounced over the past year as the euro-zone economy has slowed.

From a market standpoint, the US benefits from the high weighting of the fast-growing technology sector in its equity indices.

While tech stocks account for 30 per cent of the market capitalisation of the S&P 500, they have a less than 6 per cent weighting in the MSCI Europe Index.

Moreover, the yields on US government bonds are significantly higher than in other developed economies – particularly in Japan and Europe where a large portion of debt is trading at negative yields – which is attracting investors and driving up the dollar.

For these reasons, markets perceive the US as “the cleanest dirty shirt”. Still, America’s shirt is likely to get dirtier if the US dollar continues to rise.

The dollar index – a gauge of the currency’s performance against a basket of its peers – has shot up to its highest level in two years as other leading central banks turn dovish.

This has put emerging market currencies under strain and is endangering the foreign earnings of American companies. It was the dollar’s sharp rise last year that sparked a brutal sell-off in emerging markets, accentuating concerns about global growth.

More worryingly, the prospect of Trump being re-elected president – a distinct possibility given his enduring popularity among Republican voters and the challenge facing the Democratic Party in choosing a popular candidate who can beat Trump in next year’s election – could start to weigh on US assets.

For now, however, America remains the top choice for global investors.

Nicholas Spiro is a partner at Lauressa Advisory