Wall Street’s heavy weighting in global equities markets is far from a new phenomenon with US equities always dominating global public capital markets. The result has been that global stock markets, especially other developed markets like the UK, are traditionally tightly correlated with what is happening in the USA.
That reality is reflected in the saying “When America sneezes, the world catches a cold”.
Despite a drop in their share of total global market capitalisation of public companies over the years, Wall Street-listed stocks still account for almost 49%.
Source: Visual Capitalist
That’s partly because most of the world’s most valuable companies including Apple, Microsoft, Amazon and Alphabet are American born and raised and listed on Wall Street. But a lot of the most valuable non-American companies in the world are also listed on Wall Street, including China’s growing giants. Despite their growing economic, political and military rivalry, well over 200 Chinese firms have Wall Street listings, including tech giants like Alibaba and Baidu.
The size of the US equities capital market can make it easier for companies to raise money at higher valuations than elsewhere and to subsequently achieve superior market capitalisations than comparable international peers. That creates a virtuous circle with many of the world’s most prospective companies either shunning their domestic stock exchanges in favour of Wall Street’s or opting for dual listings.
While US equities have accounted for a higher share of total global market capitalisation in the past, over 70% in the 1970s, the last decade has seen them extend their domination again. In 2010, Wall Street’s market capitalisation accounted for around a third of the world’s total market cap. The success of the largest US tech companies over the decade since has driven that back up to almost half.
US equities look significantly more expensive than international peers despite 2022 slide
The success of Wall Street-listed companies, especially technology companies, over an extended period has, however, seen the expectation that success will continue baked into valuations. At least, that was the belief recently expressed by Karen Karniol-Tambour, co-chief investment officer of Bridgewater Associates, to delegates at the Milken Institute’s annual gathering in Los Angeles:
“Usually when you have companies win for so long, that gets priced in. You had this long period where US tech, especially, sort of ate everything. Now it’s completely priced in.”
That is backed up by the cyclically adjusted average price-to-earnings ratio (CAPE) that Wall Street-listed stocks trade at – a popular long-term benchmark which measures valuations against revenues generated over the previous decade.
Despite the S&P 500 falling almost 20% last year and returning a little under 10% so far in 2023, its current CAPE of 29 is much higher than the long-term average of 15-17.
Why analysts believe it is unrealistic to expect US equities to continue to perform as well as they have so far this century
The S&P 500 has risen by just under 10% so far this year but other major developed markets have done better. Japan’s blue-chip Nikkei 225 index, for example, is 21.45% to the good
FTSE Eurofirst 300 is up almost 25 per cent in dollars and even Japanese blue-chips are 16 per cent to the good and Germany’s DAX is up by over 13%.
Some analysts believe the slowdown in performance of US equities compared to international rivals is a product of already elevated valuations making it increasingly harder for companies to keep squeezing out more returns. Based on the long-term relationship between CAPE and performance, investors should expect US equities to return between just 3% and 5% annually over the next decade.
While CAPE is by far the only benchmark investors can look at, bears are interpreting current levels ominously. Quoted by the FT, Ian Harnett, co-founder and chief investment strategist at Absolute Strategy Research, is worried it could take a decade before the real returns, after inflation, turn positive again for US equities. He points out the 11 and 13 years respectively that process took from the historical market peaks in 1974 and 2000.
Another factor that could weigh on the returns offered by US equities over coming years is the relative strength of the US dollar. It gained 60% against a basket of other major currencies between March 2008 and September 2022, despite a global financial crisis with its roots in America’s financial system during that period.
That dollar bull market acted as an added incentive for international capital to park itself in dollar-denominated stocks. However, we may now have entered a less successful cycle for the dollar, which as shed 4% against the same basket of currencies this year, largely due to the banking sector crisis that wiped out Silicon Valley Bank and forced Credit Suisse into an emergency state-demanded takeover from larger Swiss competitor UBS.
Why US equities could still defy the odds and continue to outperform
Despite the relative strength of the bear arguments for US equities, far from all analysts and investors agree that the next decade will offer only slim Wall Street pickings. Bulls point out that historical revenues are a dubious gauge of how stretched forward-looking equity valuations are.
The lion’s share of the returns generated by US equities since the dotcom bubble burst has come from a relatively small number of the largest tech companies – companies whose business models were predicated by the internet age.
Source: Visual Capitalist
That’s again been the case this year as the market has recouped some of last years losses. The largest 20 companies, 2% of the S&P 500, had contributed 7.08% of returns as of May 24. Their combined weighting in the index is a little under 30% of its total market capitalisation.
A majority of those 20 companies, a much larger majority when only those with positive returns this year are taken into account, are tech companies that would not exist without the Internet.
Despite the growing influence of Chinese tech companies internationally, the USA still generally leads the world when it comes to technological innovation. Today’s American tech giants, and a new cohort of start-ups, are likely to lead what is expected to be the next tech revolution – AI.
If new lucrative business models are built on advances in AI as today’s tech giants rode the wave of global connectivity, the historical revenues taken into consideration by CAPE ratios could prove a poor metric for future value growth of major US indices. There could also potentially be other new technologies not yet on the radar of market participants that move the needle in favour of US equities.
What alternatives to US equities do investors have?
However, for investors who remain dubious about the potential of US equities over the next decade, what are the alternatives? If capital is moved out of Wall Street-listed stocks in favour of alternatives in other markets that look better value, which markets are worth a closer look?
Despite a good year for European equities as the continent’s economy proves itself in better health and more resistant to the war in Ukraine than many had feared, it would take a brave investor to bet on returns outstripping those on Wall Street over an extended period. Luxury goods group LVMH is the only European company worth over $500 billion and there are no tech giants or obvious future contenders for the title.
Asian equities, including China, have also recovered well this year but the latter especially is a hard sell for American capital seeking a new home due to geopolitical tensions. And without large sums of American capital, it is difficult to see where enough would come from to see the region and China outperform the US.
The lack of obvious alternatives acts as a moat that protects and supports the valuations of US-listed stocks. That makes the investment decision to move capital out of the leading, and historically best performing, stock market a difficult one.
But even if investors stay put in the hope of a new era of AI-powered returns, they should at least consider the prospect of several years of slimmer pickings than we’ve grown used to. And not dismiss the possibility that now could be a good juncture to diversify risk and perhaps dial down exposure to Wall Street in favour of the best looking opportunities elsewhere.
