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July 14, 2016

Why US stocks are outperforming and what to do about European stocks

It is easy to identify the top performing global equity funds: If they were overweight the US, they massively outperformed, if they were invested anywhere else, they underperformed badly. Even Brexit couldn’t derail US equities which keep making new all-time-highs. European equities on the other hand are far away from their 52-week highs. In addition, the US Dollar has also shown strength vis-a-vis most other currencies. For European investors, buying US stocks paid off handsomely.

Here want to analzye why US stocks have outperformed and what this means for our investment strategy going forward.

US markets are ripping but check out the rest of the world…

Over the last five years, a US index fund would have signifcantly beaten a European and even an Emerging Market index fund. In Euros, the total return of the S&P 500 is around +120% over the last 5 years while the MSCI Europe is only up around 30% and the MSCI Emerging Markets a paltry 15%.


Actually most non-US markets are far away from their 52-week highs. It has certainly been a bull market for US investors but for everyone else, it has been a pretty sobering experience.

US markets are ripping but check out the rest of the world, far right column

What are the drivers for the US outperformance?

There are genuinely good reasons why the US has performed so much better than any other major country. The following table lists a few key points. In summary – the relative safety of the US is what matters.

 USA! USA! USA!Europe :-(
Demographicsgrowing, youngstagnating, aging rapidly
Stability of currencyUS Dollar global reserve currency #1long-term viability of Euro questionable
Political unionnot in doubtlong-term viability of EU questionable (Brexit)
InnovationGoogle, Amazon, Apple, Facebook, Starbucks, Tesla, ...SAP, the youngest company in the DAX, was founded in 1972

If you prefer data, it is worthwhile looking at the earnings of the major regions, because earnings growth is what fuels equity markets. In the US, earnings are now clearly above their previous cycle high. In EAFE (Europe, Africa and Far East) as well as the emerging markets, earnings are actually lower today then 10 years ago. This is an important point because many people believe that the central bank policy is what drives markets but these charts clearly show that fundamentals are what matter most in the end. The US FED has stopped monetary easing in 2014 while the ECB is rather accelerating its aggressive monetary policy. Nevertheless, the US and EU equity markets have moved to a different tune since then.

Earnings by region

Why even bother with stocks outside of the US?

Given the outperformance of US stocks, one would be forgiven for wanting to invest only in the US. But we think this is misguided for several reasons:

1. Diversifcation. Never put all your eggs in one basket.

You think Brexit was bad – what about a Trump presidency?

2. Historical perspective. The long-term performance is very similar.

If you only look at the last 5 years, you might get the impression that investing in Europe is a pretty hopeless undertaking. But if you take a longer-term view, the performance is surprisingly similar. Over the last 45 years, the US delivered an annual performance of 10,3% while Europe was very close with 10.0%

 S&P 500 annual returnMSCI Europe annual return

The relative outperformance of the US vs Europe is very cyclical. This following graph shows the rolling 5 year over- and underperformance of US stocks. There are often long stretches when the US outperforms and then there are years when Europe finishes first. While anyone who bet heavily on the US 5 or 10 years ago should be highly praised, you have to realize that the current phase of US outperformance is starting to get long in the tooth.

US EU 5y rolling performance

3. Valuation. Buying expensive is the wrong way to target above-average returns.

The reasons for the US outperformance are well known (see list above). But the problems of Europe probably too. This is reflected in the valuation. Currently the S&P 500 trades on 19x 2016 earnings while the MSCI Europe trades on 15x.

You could rightly argue that this premium is well deserved and that Europe is a potential value trap. However, we think the P/E multiple comparison is not showing the true picture. After all, US earnings are above trend while European earnings are below trend. If you normalize earnings by taking the 10 year average (so-called Shiller P/E) you get a much starker picture. Fact is that the US is highly priced versus history AND that the profit share is very high AND that the wage share is very low AND that the tax share is very low. Not a good starting point for future above-average performance.



Summary – the best investment decisions are uncomfortable

The US economy has a better outlook than most other countries – but US stocks are relatively expensive. We think investors are currently paying a lot for the perceived safety.

The paradox of successful investing is that it is rarely ever going to be comfortable to invest where the best bargains are to be found.


JP Morgan Asset Management – Guide to Markets – Q3 2016


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