By Lewis Krauskopf
NEW YORK (Reuters) – U.S. stock prices are outpacing those in most other regions to start 2019, but the gap is narrow and some investors are eyeing potential catalysts to tip the scales to the rest of the world.
Investors say several factors could sway performance in favor of other developed or emerging markets, including slowing U.S. profit growth, a weaker U.S. dollar, improving economies in China and Europe and resolution of global trade tensions.
The 11 percent gain this year for the S&P 500 is helping the U.S. benchmark index expand its global edge since the U.S. equities bull run began a decade ago.
U.S. stocks are near 70-year highs relative to other global developed markets, according to Bank of America Merrill Lynch.
“For the most part, it has been a pretty consistent trend that U.S. outperforms non U.S.,” said Nathan Thooft, head of asset allocation for Manulife Asset Management in Boston. “The reality is, though, it can’t go on forever.”
U.S. corporate earnings are expected to climb 5.3 percent this year after rising 24.4 percent in 2018, according to global markets research at FTSE Russell.
European companies, excluding the UK, are expected to see profits rise 9.1 percent this year, while profits for emerging market companies are projected to rise 13.9 percent.
Moreover, the S&P 500 is trading at 16.4 times earnings estimates for the next 12 months, more expensive than the 13.4 times for Europe’s STOXX and 11.5 times for the MSCI emerging markets index, according to Refinitiv data. Moreover, the S&P 500’s valuation gap over those indexes is wider than it has been historically.
“People are willing to pay a very hefty premium for the U.S. stock market,” said Lance Humphrey, a portfolio manager with USAA Asset Management. “It’s our view that the fundamentals in the U.S. don’t necessarily justify the degree of that premium.”
That valuation difference has been one attraction in particular for emerging markets, which was the “most crowded trade” in a BAML fund manager survey last month.
The strength of the U.S. dollar is another factor for emerging markets, many of which have debt denominated in the greenback. For U.S. investors, a strong dollar also requires a costly currency translation for investments in international funds.
Investors say the dollar has held up surprisingly well this year, given the more dovish stance by the Federal Reserve, but any weakening in the U.S. currency could be a boon for stocks outside the country.
Resolution of the trade dispute between the United States and China could provide another boost, as investors have become optimistic about a deal between the world’s two largest economies.
“If China and the U.S. can reach a good agreement, that will actually propel emerging markets and have a bigger impact on emerging markets than on the U.S. market,” said Chris Gaffney, president of world markets at TIAA Bank. “All the emerging markets are somewhat dependent on China because that’s their largest trading partner for the most part.”
The potential for a positive trade resolution has helped fuel the 22 percent run this year for China’s Shanghai Composite index, which has outperformed both U.S. and other major world indices.
Europe’s STOXX has climbed 10 percent this year. A weak economic outlook – the Euro Zone economy is expected to expand 1.3 percent this year, just over half the U.S. rate – along with political uncertainty in Britain and elsewhere have pressured equities.
Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, last week issued a report saying European equities should top U.S. equities, noting that “modest economic growth forecasts look achievable.”
“The best thing going for Europe right now is no one has expectations,” said Keith Lerner, chief market strategist at SunTrust Advisory Services in Atlanta. “What that means is a little bit of good news could go a long way.”
One factor driving U.S. outperformance this year is the heavy weight of technology stocks in the country’s indexes. Nearly one-quarter of MSCI’s U.S. index is tech companies, compared with 15 percent in financials. By contrast, MSCI’s European Union index has a 19 percent weighting in financials and 6 percent in tech.
Tech and other high-growth stocks have been in favor, but some investors anticipate a shift toward financials and other value stocks, so Europe could see a relative boost.
Of course, not everyone agrees. Nicholas Colas, co-founder of DataTrek Research, doubts that financials will lead this year, which is one reason he prefers the S&P 500 over indexes for other global regions.
Indeed, Willie Delwiche, investment strategist at Baird, says geographic diversification away from the U.S. market has hurt returns, so investors “are going to be a little bit gun shy” to allocate to the rest of the world.
As it stands, Manulife’s Thooft said, “there is no doubt that U.S. assets are over-owned.”
(Reporting by Lewis Krauskopf; Editing by Alden Bentley and Dan Grebler)