Source: Bloomberg Finance LP Data as at 31 December 2024
The most recent period of US stock market outperformance has been supported by positive economic and financial drivers, but these may be vulnerable to shifting macroeconomic forces and geopolitical risks.
Since mid-2008, the S&P 500 has beaten the MSCI EAFE Index (this index measures the performance of large and mid-cap companies across developed markets countries, excluding the US and Canada), by a sizable margin, delivering average annual returns of 11.9% versus 3.6% through December 2024.11
Over the same period, the S&P 500 grew earnings four times faster than MSCI EAFE and boasted price-to-earnings (P/E) multiple expansion of 12.8x to 21.7x, compared to the MSCI EAFE’s expansion of 11.3x to 14.0x.12
Using return on equity (ROE) as a measure of how efficient companies are with their equity capital, the S&P 500 has maintained a higher ROE than the MSCI EAFE Index since June 2008, and that spread has widened over time.13 Currently, ROE for the US market is 19% versus 12% for EAFE.14
We think several factors have driven that difference, including US technological innovation, more efficient operations and shareholder-friendly government policies, such as corporate tax cuts.
The combination of higher earnings growth and ROE have led investors to place a higher P/E multiple on the US equity market. At the start of 2025, the US stock market premium versus EAFE on a forward P/E basis was hovering at 55%, near its all-time high, although recent market volatility has narrowed the gap.15
In this context, it’s easy to see how the booming tech sector has contributed to US earnings growth and multiple expansion.
What may cause shift in market leadership?
US share market exceptionalism has been a powerful trend, but it is arguable that risks, especially in the tech sector, are rising.
Recall what happened in late January when the announcement that Chinese AI startup DeepSeek had developed and launched a competitive large language model pushed US tech stocks’ valuations sharply lower.
Uncertainties about the direction of US economic and foreign policy have grown and consumer sentiment appears to be weakening.
To be clear, investors expect US earnings to keep growing but for US outperformance to persist, US company earnings will have to grow faster than those outside the US.
That may not be so easy to do. As soon as the news about DeepSeek broke, for example, the US market’s relative valuation to the MSCI EAFE dropped from 55% to 49% and declined more recently to around 39%.16
Recent market events underscore how vulnerable US equities may be to higher tech-stock volatility, disruption from tariffs, and cresting US consumer confidence.
With all that’s coming out of Washington these days, it is understandable that people are looking for cracks in America’s financial and economic dominance.
When doubts emerge, it’s timely to be reminded of a Warren Buffet quote: "In its brief 232 years of existence ... there has been no incubator for unleashing human potential like America. Despite some severe interruptions, our country's economic progress has been breathtaking. Our unwavering conclusion: Never bet against America."17
As robotics and artificial intelligence emerge as the latest sources of technological advancement and economic growth, the US boasts leadership in these arenas, notwithstanding ripples created by DeepSeek.
The US Federal Reserve continues to be the central bank that sets the direction for global interest rates, credit creation, and on it goes.
A rich investment approach
The themes discussed in this note are captured by our rich investment process which draws far and wide for insights. Both short and longer term economic and asset class dynamics are analysed, as are structural themes.
Moreover, we actively interrogate the many ways in which markets and economies may progress rather than dogmatically settling for a base case and making investment decisions through a narrow lens.
As ever, we have leaned on our asset allocation and diversification expertise to steer our clients’ portfolios through this year’s market volatility.
Recognising that US stocks, led by the Magnificent Seven, had become a disproportionate part of the global share market, and the risks this posed, we have had an ‘underweight’ position to the US share market for some time and instead deployed more of our clients’ funds to non-US markets, which we judge as being better valued.
We have also maintained our exposure to alternative investments, like insurance related investments, which provide an attractive source of diversification given their performance is not related to share markets.
We hold real assets via unlisted infrastructure and unlisted property investments, which provide diversification benefits, along with long-term, stable and predictable cashflows often linked to movements in inflation.
In our view, higher macroeconomic uncertainty works against ‘swinging for the fences’ asset allocation moves. Instead, the emphasis is on fine-tuning portfolios and skilful risk management so that they can play both defence and offence.
On the defensive part of the equation, we have in place derivatives strategies that can protect portfolios should the US equity market weaken. By the same token, our portfolios’ strong liquidity has meant that we have been able to acquire assets at attractive valuations on the back of recent disruptions.
