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Mind the gap: US vs ROW


In this month’s video, Investment Director, Ritu Vohora looks at the sharp divergence in equity markets. Are we at an inflection point?

For a quick snapshot of the equity market over the past month and our latest theme, please download our Equities market perspective note.



Hello and welcome to this month’s equity market review with me, Ritu Vohora.

Despite the best efforts by bears, markets have so far been rather resilient. The MSCI World index is up some 4.3% year-to-date, in dollar terms. The performance is US centric, with the S&P500 posting its best quarter since 2013. While US and Japanese shares raced ahead, Europe’s shares were left behind in the third quarter. 

The European index is now trading below where it was a year ago. The big driver behind the outflows this year has been geopolitics, as well as, European companies being more exposed than those in the US, to emerging markets. The developing world has been hit by a rising dollar, fears about protectionism and expensive oil. 

In fact, oil has posted the longest string of quarterly gains in more than a decade, as market concerns grow about Iranian sanctions and an impending supply crunch. Some energy giants and Wall Street banks have predicted the return of a 100-dollars-a-barrel crude.

Elsewhere, the Fed raised US interest rates in the last week of the month and said it planned four more increases by the end of 2019, amid robust economic growth and a strong job market. 

From a sector perspective, it was a mixed bag in September. Unsurprisingly, energy dominated sector returns, alongside telecoms and healthcare. In a trend reversal, technology lagged. Interestingly, we are now seeing a divergence between US and Chinese internet leaders, with Alibaba and Tencent lagging their US peers. 

Global equity markets sit at an important juncture. They have diverged sharply this year, with the US roaring to new highs, while most non-US equity markets have faltered since hitting cyclical peaks earlier this year. The outperformance of US versus the rest of the world has now hit historical extremes. Indeed, a successful strategy over the past eight years has been to own US stocks against other regions and a preference for growth over value. There is a strong correlation between these two strategies. But are we nearing an inflection point? 

Global growth in aggregate remains robust, but patterns are no longer synchronized. While the fiscally boosted US expansion goes on, growth in Europe and Japan has slowed, Chinese efforts for deleveraging have led to some moderation, and the outlook for parts of EM has deteriorated. The combination of trade tensions, higher oil prices and tighter dollar liquidity are weighing not only on China and other emerging markets, but also on export-reliant developed countries such as Europe. 

The US is comparatively insulated and still retains several advantages including superior domestic economic growth momentum, strong corporate earnings - boosted by this year’s tax cut and dollar appreciation. Rising trade tensions have also seen investors flock to the safety of the US. This coupled with slow-but-steady Fed hikes, has sparked significant inflows into the US, boosting US-dollar assets. The latest Bank of America Merrill Lynch fund manager survey shows the largest overweight to US equities since 2015 and it is now the top equity region. But with relative outperformance and valuations looking extended – is all the good news now priced in? 

The rich US valuation premium by itself is unlikely to be a catalyst for a reversal of relative share price performance. However, combined with stretched relative performance, any shift in underlying earnings fundamentals could trigger a pronounced swing in performance. 

The divergence in stock market moves contrasts with the similar path of analysts’ earnings estimates for companies across the US, Japan and Europe. Analysts’ consensus estimates for earnings over the next 12 months are rising at a high single-digit to low double-digit pace across all three regions.

The divergence between stock performance and earnings estimates may be attributable to widening differences in the degree of confidence in those forecasts, due to tax cuts and trade tensions, among other factors, affecting the relative growth outlooks. Although earlier this year, economic data was better than expected in the US, it was worse than expected in Europe and Japan. The economic surprise indices now reveal that data in the US, Europe, and Japan is coming in close to expectations. If economic data begins to come in better than expected broadly across all regions, it is possible that performance divergence may unwind, as confidence in the earnings outlook improves outside of the US.

Further, a shift in relative earnings momentum would coincide with the one-time boost from US tax reform and fiscal stimulus starting to wane. A re-convergence of earnings growth expectations between US and select non-US markets should narrow the current valuation gap. That would also argue for value to do better than growth, especially in the US, as momentum starts to roll-over.

Near-term risks have risen, but that can help the long-running bull market continue, as investor enthusiasm remains lacking. Risks exist on both sides—pullbacks are possible but so are breakouts to the upside. As ever, selectivity will be important in the months ahead. 

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That’s it from me and see you next time!


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