Can global mkts keep rising? Financial history favours investing outside US

Risk assets had a good run in 2024, with Bitcoin, gold and US equities in particular outperforming. The S&P 500 index in the US experienced its second consecutive year of returns exceeding 25 per cent. The last time US equities delivered two consecutive years of over 20 per cent returns was during the dot-com bubble in 1997-98. As has been the norm, emerging market (EM) assets lagged, with EM equities up only 8 per cent for the year, and European equities rising by 9.5 per cent. American exceptionalism was alive and well! Gold outperformed equities, as it has over the last 25 years, rising by 27.5 per cent, and Bitcoin was the star with a return of 120 per cent.

 

I am less positive than many on the US equity markets and American exceptionalism. I worry about elevated valuations, surging retail sentiment, and the risk of an inflationary resurgence. The risk of bond markets starting to riot is also top of my mind.

 

If you look at the CAPE (cyclically-adjusted price-to-earnings) ratio, the only time it has been higher was during the dot-com bubble of 1999-2000. On alternative valuation metrics of price-to-book or price-to-sales, we have already crossed the dot-com bubble levels. I find it difficult to believe that we have any further scope for multiple expansion left. As data on financial market returns over the last 25 years shows, starting point valuations matter greatly when forecasting long-term returns. Can you really make good long-term returns from US equities when your starting point is arguably the most expensive in history? Financial history would suggest this is a bad bet.

 

On inflation, we are still not at 2 per cent on the personal consumption expenditure (PCE) deflator, and there are signs that inflation is proving to be more sticky than originally thought. Jobs, interest rate-sensitive consumption and the US economy are proving to be more resilient than forecast. The US Federal Reserve itself seems to have turned decidedly more cautious regarding further rate cuts and their timing. We have yet to see what Donald Trump actually delivers on the tariff front and immigration, but were he to follow through on his campaign pledges, it would not be impossible for the next Federal Reserve move to be a hike, rather than a cut in rates. This is in no one’s forecasts for 2025. It would be a shock to the markets.

 

Bond markets seem shaky globally, with fiscal challenges facing developed markets becoming evident, alongside a lack of political will to address these issues. Can markets handle bond yields crossing 5 per cent, which no longer seems beyond the realm of possibility. From an equity perspective, I believe it makes sense to tilt portfolios towards EMs and Europe, taking a contrarian bet against the continuation of American exceptionalism. It has become the default assumption that America will outperform forever and that any other geography is a waste of time. The consensus and positioning are clear on this. Many active investors today have never experienced a period of US underperformance, as US equities have outpaced all other markets for 16 years straight. It has, however, not always been so — just consider relative regional performance in the lead-up to the global financial crisis (GFC). Given relative valuations, investor positioning and the current overvalued dollar, I see merit in being contrarian here. No asset class or region outperforms forever.

 

However, it always makes sense to consider the other side. What is the bullish thesis for the US? Where could we be wrong? Just going through some of the bullish notes on the US from various banks and commentators, the following arguments are clear. Many do not worry about valuations, as it is not a timing indicator. Markets can remain overvalued on conventional metrics for years. The reality is that if we go back to the dot-com bubble, equity markets continued to rise for another two years after the CAPE ratio had reached current levels. This can happen again! During the dot-com bubble, markets delivered four consecutive years of 20 per cent-plus returns. The fact is that you could be right about this being a new bubble, but markets may still deliver a strong performance in 2025 regardless. US economic growth expectations are still only about 2.1 per cent, but the economy is performing very well, and there is a clear upward bias to these numbers. US growth continues to surprise positively, with the Fed cutting into a soft landing. A scenario of growth surprising positively, with financial conditions accommodative and the Fed cutting rates has historically been very good for financial assets. Interest rate cuts into a soft landing have historically been very bullish for equities.

 

Many believe that the huge investments in artificial intelligence (AI) are not a waste or a bubble. The surge in capex will front-load corporate profits and supercharge productivity. The US is already experiencing labour productivity of over 2 per cent, much higher than any of its G7 peers. Higher trend productivity will lead to higher economic growth, better corporate profitability and lower inflation. The US is the world leader in AI, both in terms of technology and investments. Just four American companies — Alphabet, Meta, Amazon, and Microsoft — are set to spend upwards of $240 billion on AI-related capex in 2025. No one else is even close. This could lead to breakout economic performance. If AI is a platform-shift technology like the internet, who knows or can predict the positive effects of all this investment?

 

There are absolutely no signs of a recession in the US, or even the economy slowing. Many recessionary leading indicators like the yield curve or Sahm rule have actually reversed in the last couple of months. Absent a recession or slowing economy, it is rare for equity markets to sell off significantly. The Fed is still looking to cut rates, not raise them, again not the typical setup for falling markets.

 

It remains my view that the only way to make money in US equities from here is to assume that we are repeating the dot-com bubble. Given where we are in terms of retail sentiment, the narrowness and tech-heavy nature of the market advance, and relative valuations, markets are in a zone of high vulnerability. The odds favour investing outside the US, no matter how hard that may be to get through investment committees. You may choose to play the greater fool theory, remain invested and overweight the US, and assume that you can exit the markets before it all comes falling down, but most of us are not nimble enough to play this game. Buyer Beware.

 

The author is with Amansa Capital