Confidence in the domestic economy has driven up U.S. stock indexes as growth has cooled in the eurozone and emerging markets. Photo: Richard Drew/Associated Press.
U.S. stocks are trading at their highest premiums to international shares in years, reflecting bets among investors that the domestic economy will keep powering past its peers around the world.
After a tepid first half of the year, the S&P 500 surged 7.2% in the third quarter, its biggest gain since the end of 2013.
Investors credit the latest leg of the rally to faith in the U.S. economy, which has shown fresh vigor this year even as growth has cooled in the eurozone and emerging markets.
But the rally has come at a cost: U.S. stocks have become increasingly expensive compared with major indexes elsewhere, something that some analysts worry could leave the market vulnerable to a snapback heading into the final months of the year.
On a price/earnings basis, U.S. stocks are trading at a 12% premium to an MSCI index of 22 developed markets and 24 emerging markets. That is the biggest gap since 2009, according to Bank of America Merrill Lynch. For the year, the S&P 500 is up 9.4%, while the Stoxx Europe 600 is down 1.3%, the Shanghai Composite has fallen 15% and Japan’s Nikkei Stock Average rose 6.5%
“It’s hard to imagine that the divergence in valuation is sustainable,” said Jack Ablin, chief investment officer of Cresset Wealth Advisors. “Good things are happening in the emerging world, but global investors are attracted to the U.S. at the moment.”
Many investors were less worried about a U.S. stock reversal just a couple months ago. Then, surveys showed the eurozone economy stalling and emerging markets from Indonesia to Turkey to Brazil tumbling as the dollar strengthened. U.S. stocks, investors said, increasingly looked like the haven assets of the world.
But since then, the dollar has weakened as investors have taken the U.S.’s and China’s latest trade skirmishes in stride, leading some market watchers to ask whether the yawning gap between stocks in the U.S. and the rest of the world is on borrowed time.
Nearly 50% of investors believe the divergence in the global economy will end with U.S. growth decelerating, according to a September Bank of America Merrill Lynch survey of global fund managers. In comparison, just 28% of investors believe the divergence will end because of growth in Asia and Europe accelerating.
“If you look at [U.S.] valuations, absolute performance…they are all extremely stretched,” said Julian Emanuel, chief equity and derivatives strategist at BTIG. “We are very sympathetic to this idea that there’s going to be a convergence between the U.S. and the rest of the world.”
There are plenty of catalysts that investors say could put the U.S. rally at risk.
Technology stocks have faltered in September after a stunning run over the summer that included Amazon.com Inc. and Apple Inc. both topping $1 trillion in market capitalization. The Nasdaq Composite fell 0.8% in September, notching its biggest monthly decline since March, when revelations that Facebook had improperly handled its users’ data sent tech stocks tumbling.
The group’s drop has left some investors wondering whether the moves could be the start of a deeper downturn for the technology stocks—and if so, what other groups will be able to carry the market forward.
Rising interest rates are another potential threat: After languishing in the middle of the year, the yield on the 10-year Treasury note has made a run above the 3% mark, pushing up borrowing costs for everything from homes to cars. Analysts worry that further weakness in the housing market in particular could bode poorly for the broader U.S. economy.
Yet few of the risks seem immediate enough for investors to call it quits on the U.S. rally. Flows into mutual funds and exchange-traded funds tracking U.S. equities jumped to 27-week highs in mid-September, according to fund tracker EPFR Global.
Moreover, there are few signs of the economic expansion stalling. Data have shown a measure of U.S. consumer confidence at 18-year highs, corporate earnings charging forward and the Federal Reserve Bank of Atlanta’s GDPNow model estimating close to 4% growth for the U.S. economy in the third quarter.
At the same time, many still see reasons to be cautious outside of the U.S.
International Monetary Fund Managing Director Christine Lagarde warned Monday that emerging markets could suffer a flood of outflows if the turbulence that has hit Turkey and Argentina this year spreads beyond those borders.
That has made investors willing to avoid emerging-markets assets in favor of relatively expensive U.S. stocks.
“The U.S. is basically leading the rest of the world in growth, both economically and at the corporate level. Other areas of the world look more attractively priced, but it may just be a big value trap,” said Robert Pavlik, senior portfolio manager and chief investment strategist at SlateStone Wealth.
Even those who believe that the divergence between the U.S. and the rest of the world looks stretched say it is difficult to time when the two will start to converge again.
Heading into the fourth quarter, portfolio managers are likely to put money into areas of the market that have outperformed while backing off trades that have underperformed, according to BTIG’s Mr. Emanuel.
That is likely to inhibit market convergence in the short term, BTIG’s Mr. Emanuel said.
“The tendency historically is for the things that have been working to continue to work,” he said.
Corrections & Amplifications
For the year, the S&P 500 is up 9.4%, while the Stoxx Europe 600 is down 1.3%, the Shanghai Composite has fallen 15% and Japan’s Nikkei Stock Average rose 6.5%. Earlier versions of this article incorrectly stated the figures as 1.5% for the S&P 500; 15% and then 1.4% for the Stoxx Europe 600; and X% for the Shanghai Composite. (Oct. 4, 2018)
Write to Akane Otani at akane.otani@wsj.com
Appeared in the October 2, 2018, print edition as ‘U.S. Stocks Widen Global Lead.’
Source: WSJ
