An End to U.S. Stock Market Exceptionalism?

The Wall Street Journal, 3/15/21, headlined, “Value Stocks in Europe Draw Investors.” Citing “a rotation from growth to value stocks,” the article noted increased buying of “companies hit hard by the pandemic and selling of those benefiting from stay-at-home orders.” In a First Quarter 2021 report from a mutual fund group, the buying shift was postulated by Sean Markowicz, CFA, Strategist, Research and Analytics, at London-based Schroders Investment Management. He noted that during lockdowns midst rising demand for digital services, large tech firms soared in value. Behemoth growth stocks saw rising price/earnings (P/E) multiples as investors, especially those still getting paychecks with fewer places to spend them, poured money into tech-oriented stocks and US index funds. As large-capitalization growth stocks made up an increasingly large segment of total US market capitalization, indexes hit new highs. Now, a growing preoccupation with value has ensued.

Per Markowicz, “Cyclical opportunities lie outside the US. Whereas the US equity market has only a 37% market-cap weighting in cyclical sectors, the rest of the world has a 55% weighting. Non-US companies have more exposure to energy, industrials, and materials, which tend to perform well in a recovery.” The WSJ quoted Kasper Elmgreen, CFA, European large cap stock analyst at Amundi Asset Management, Dublin, Ireland, who opined, “Europe is predominately a value market, the US is predominately a growth market. This rotation benefits Europe disproportionately.”

As of March 15, 2021, the Stoxx Europe 600 index had gained 4.5% in the month, near its yearly high. The S&P 500 gained 3.5% in the same period. But note, the Russell 2000 index of small-cap American companies, what some call “Main Street stocks,” increased 6.9%. The Russell 2000 is viewed as a “bellwether of the American economy” as smaller businesses are focused on the domestic market. As the pandemic took hold, shutdowns hit smaller companies hard. Growing optimism regarding an American recovery has prompted an investor shift from potentially overpriced large cap stocks to smaller domestic sectors. A shift from growth to value has benefited both selected American and non-US markets.

Conversely, the tech-heavy Nasdaq Composite gained only 1% in the above noted period. On 3/15/21, the Invesco QQQ Trust, an ETF which tracks the Nasdaq, opened 6.6% below its 52-week high achieved on 2/16/21. Note that we’re talking about short-term performance in March, which should be taken only as a potential harbinger of market direction. Sean Markowicz points to the fact that US share prices reflected by the MSCI USA index trade at “33 times their cyclically-adjusted historical earnings compared to 18 times for global equities.” He observes that many stocks are “expensive everywhere,” but that “doesn’t mean a global stock market crash is imminent. It just means future long-term returns could be lower.” He theorizes that “tech-market concentration” could hinder US performance going forward. During the lockdowns the largest American technology companies─Apple, Microsoft, Amazon, Facebook, and Google─saw their market capitalizations soar as those who worked and shopped from home boosted profits. From 1/1/20 to 1/29/21, the MCSI USA index returned 23%. Drop the above five stocks from the 620 index constituents, and the remaining 615 stocks delivered only 15% in total.

After the $1.9 trillion pandemic relief bill budget blowout, the Biden administration is debating how to pay for spending on infrastructure, clean energy, and education.  Higher taxes on corporations could render a blow to US corporate earnings, impacting stock prices and P/E calculations. Higher taxes on individuals, and on long-term capital gains and dividends, could take some of the luster off of stock investing and the harvesting of gains. Higher estate taxes could complicate estate and succession planning for families and individuals relative to high value but non-liquid assets like farms, ranches, and closely-held and non-publically traded business interests.

Bolstering the international case, emerging market equities suffered as a result of US-China trade tensions and tariff fights. Improvements in international relations with positive results for global trade activity could lift prospects for firms involved in export-oriented emerging markets.

For the average investor, with so many constantly changing pros and cons, the answer lies in a diversified portfolio with well-vetted managers, held with longer time frames in view. In our opinion, the growing focus on “value” has legs.