If there were an Olympic Games for the equity markets, Team USA would be dominating this year’s medal count. While nearly every major global index has rebounded since the late-2018 selloff, few markets have rallied like those in the U.S. The following chart shows the relative performance of the S&P 500 compared to the rest of the world. Granted, the S&P 500 was hit harder than global markets in the fourth quarter of 2018, but since then the index has recouped nearly all of those relative losses.
This strong year-to-date performance means that the plethora of cheap U.S. stocks that could be found in December has now vanished. The next table illustrates how the S&P 500 (top) is now close to its all-time high valuation on many different metrics. By comparison, European markets (bottom) seem to be valued only slightly above average.
The following chart demonstrates this valuation difference graphically. It shows the relative price-to-earnings (P/E) multiple of the S&P 500 versus the rest of the world. You can see that the current valuation difference is close to its highest level, going back to at least 2004.
So what has been driving this U.S. outperformance? Well it seems like investors have an insatiable appetite for growth, and the U.S. has a lot of high-growth companies. The next chart groups companies by future revenue growth estimates on the x-axis. You can see that Europe (dark blue) has a lot of low growth companies, while the U.S. (light blue) has a lot of companies growing at 10%+. This difference is likely thanks to the U.S.’s thriving technology sector.
Not only have U.S. markets benefited from having a large number of high-growth companies, but investors have shown a willingness to pay more for them. The next chart also groups companies by future revenue growth estimates on the x-axis. What the two lines illustrate is that investors are now rewarding the same level of future estimated growth with a higher P/E multiple than they have historically.
While we’ve focused on the S&P 500’s outperformance since the start of the year, this recent performance isn’t a new phenomenon. The next chart shows how major asset classes and major economic indicators have performed since the financial crisis. Leading the way? The S&P 500.
Source: Goldman Sachs Global Investment Research
Not only has the S&P 500 outperformed other major assets since 2009, it has also outperformed its own historical recoveries. The next chart shows that ten years into its average recovery, the S&P 500 was historically up more than 150%. Since 2009, however, it has been up almost 350%. This outperformance is because of the two reasons we discussed earlier: (1) there are lots of high-growth companies in the U.S., and (2) investors are now paying more for future growth than they have in the past.
Source: Haver Analytics, Datastream, Oscar Jorda, Moritz Schularick and Alan M. Taylor, Goldman Sachs Global Investment Research
Actually, we can quantify what has been responsible for the strong performance of the U.S. markets versus the world. Indeed, it has been a combination of earnings growth (generating 73% of the performance) and valuation expansion (generating 27% of the performance), as shown in the next chart.
Source: FactSet, Worldscope, Datastream, Goldman Sachs Global Investment Research
We bring all of this to your attention for two reasons. First, our Canadian financial media is often dominated by U.S. headlines, which can skew our view of the world. Many Canadian investors may be under the impression that their portfolios have performed at a similarly-impressive level as the U.S. markets since the recession. In reality, the S&P/TSX Composite index is up 6.1% annualized since the end of 2008, whereas the S&P 500 is up 12.1% annualized. That’s a significant difference: it means that $100 invested in the TSX would have grown to $186 while the same amount invested in the S&P 500 would have grown to $331.
Secondly, these charts illustrate some of our concerns with present-day valuations in the U.S. As we mentioned last month, we’re happy to buy a company with high growth potential, and we love seeing earnings actually grow. But there is a price to be paid for this growth, and investors have been driving this price higher and higher in recent years. This is why we’ve been finding it easier to identify cheap stocks outside of the U.S. in recent periods. Thankfully, the mandate of the Cowan Absolute Return Fund allows us to look globally. Otherwise, we would now find ourselves in the undesirable position of hunting for bargains in an increasingly-crowded marketplace.