LONDON/NEW YORK, Jan 26 (Reuters) – U.S. stock markets, after posting their best three-year run in more than two decades, may soon have to give way to the top spot.
As the Fed prepares to raise interest rates for the first time in nearly four years, capital is beginning to flow into rate-sensitive US stocks in other parts of the world where markets are cheaper and potentially more resistant.
The nearly 10% drop in the S&P 500 so far this year has outpaced the losses of most non-U.S. indexes and some believe the recent investment outflows from the market, the first in a month according to BofA, are not only the beginning.
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Goldman Sachs’ analysis of eight cycles of Federal Reserve hikes since 1975 seems to support this view.
The bank found that European stocks outperformed their US counterparts by an average of four percentage points over six months after the Fed’s first rate hike.
He also saw a clear rotation towards so-called value sectors such as banks and commodities which are better represented in European and emerging market equity benchmarks.
“What that means is get the hell out of the United States,” said Mike Kelly, head of global multi-assets at PineBridge Investments. “It’s about selling longer duration assets, so we’re underexposed to US equities.”
Longer duration stocks, in a nutshell, are those whose prices are determined by expectations of future earnings potential and therefore do well when interest rates are low.
US tech companies with their exorbitant valuations as measured by their price-earnings (PE) ratios are a prime example and they make up more than a third of the S&P 500.
For years, these stocks have been a magnet for investment, benefiting from rock-bottom interest rates and, recently, the shift in weather from the pandemic to work, shopping and eating-at-home.
Of the $1 trillion invested in equities last year, dedicated funds in the United States took a third. They would also have received the lion’s share of the nearly $500 billion absorbed by global mandate funds, according to Deutsche Bank.
Now, says Kelly, the markets are at an inflection point, far from when “the PE rose and interest rates fell.”
Given that five megacap companies accounted for a third of S&P 500 performance last year, unloved US sectors should also benefit from the rotation.
Martin Schulz, senior portfolio manager at Federated Hermes, said he had been overweight international developed markets since last fall, betting on a broad global economic recovery. “The cyclicality of the European markets, the Japanese markets…we think they are going to be the big beneficiaries of this globalized recovery in the short term.”
Nearly $6 billion fled from U.S. equities in the week to Jan. 19, while European and emerging-market funds absorbed $2.7 billion and $5.2 billion, respectively, according to BofA.
Morgan Stanley strategist Graham Secker also cited internal data showing outflows of $5 billion from U.S. exchange-traded funds (ETFs), while those focused on U.S. domestic stocks lost $8.5 billion. billions of dollars. European equity ETFs gained $3.6 billion.
“We’re finding it qualitatively with investors around the world, to shift some weight from the US to other countries,” Secker said.
Monday’s rout reverberated globally, as European stocks plunged 4% for their worst day since mid-2020 and emerging stocks lost 2%. Yet they may be relatively better placed to deal with a stricter policy.
Europe is trading at a 27% discount to Wall Street, compared to an average discount of 15% before the previous three Fed cycles, Goldman Sachs estimates. And value stocks are 50% cheaper overall than their growth peers, double the discount seen before past rate hikes.
Europe also offers more positive economic surprises and upward earnings revisions than the United States, Secker noted.
EMERGING MARKETS TOO
All markets will feel it when central banks slow the flow of cash, and depending on what the Fed does, the net supply of cash from the big four central banks could even shrink for the first time in years.
But this cycle differs on one point from the previous one; China, which raised rates in 2018 alongside the United States, is now easing policy to support its economy.
Looser Chinese policy will benefit other emerging economies and export-focused Europe through trade and commodity prices and could drive Asian stocks up 10% in 2022, JPMorgan wrote.
Kevin Mahn, chief investment officer at Hennion & Walsh Asset Management in New Jersey, remains bullish on US equities but believes other markets may soon start to shine as well.
“Maybe they’ll start to see some of the growth that we’ve seen in US markets over the last three years,” he added.
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Additional reporting by Danilo Masoni, Saikat Chatterjee and Marc Jones Editing by Tomasz Janowski
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