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Markets

Doubting America Can Cost You a Lot of Money

Waiting for U.S. stocks to revert to the mean has meant sitting back and watching in horror. Goldman has been right to keep faith.

Doubting America Can Cost You a Lot of Money

Waiting for U.S. stocks to revert to the mean has meant sitting back and watching in horror. Goldman has been right to keep faith.

Still on top.

Still on top.

Photographer: Drew Angerer/Getty Images

Still on top.

Photographer: Drew Angerer/Getty Images

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America Ascendant, Goldman Ascendant

U.S. stock markets have far outpaced the rest of the world since the crisis. They have done so relentlessly and consistently. In the process, stocks have grown very expensive by conventional metrics. Most stock markets in the rest of the world have not. This leads many (including me) to fear that we are due for a big reversion to the norm. The U.S. cannot stay dominant that long.

I have been making variations on this argument for many years now, and they have all been wrong. (Or, at least, too early — and any Wall Streeter will tell you that means the same thing.) So I was glad of the opportunity to talk to Goldman Sachs Group Inc.’s Sharmin Mossavar-Rahmani, who has for years been the CIO of the bank’s investment strategy group, and has year after year since the crisis been making the same two-part call: stay invested in stocks, and expect America to remain preeminent. I have a strong inclination to dismiss this as an investment bank’s natural urge to be bullish at every opportunity, but unfortunately for me this call turns out to have been correct so far. The latest outlook from Mossavar-Rahmani’s team is called “Room to Grow” and features a baobab tree on the cover, because such trees can keep growing for centuries. So nobody can fault them for hedging their bets.

The first stage in the argument is that, very simply, U.S. companies have managed to increase their earnings in a big way since the crisis. Companies in the emerging world, and in the rest of the developing world, have not. She is right about this. This is in part because the FAANG 1  internet giants come from the U.S., and now make large chunks of their profits elsewhere, but that doesn’t affect the argument for buying equities from the U.S. rather than elsewhere. This chart compares 12-month forward earnings for MSCI’s indexes of the U.S., emerging markets, and EAFE (Europe, Australia and the Far East):

Outside the U.S., earnings have not returned to their pre-crisis peaks

Beyond that, there is exorbitant privilege. If investors want a shelter, where can they find it other than in the U.S.? Both the euro zone, thanks to its sovereign debt crisis, and arguably also China, with its badly mismanaged currency devaluations of 2015 and 2016, have shown that they cannot match American assets as a shelter. The U.S. is still the place to go in a crisis. This was rammed home in 2011, when investors sought shelter from the shocking decision by Standard & Poor’s to downgrade U.S. Treasury debt from AAA by buying Treasuries.

The Goldman team argues that the coronavirus outbreak only serves to underline continuing American preeminence. Even if Peak Fear about the virus in markets passed some two weeks ago, Mossavar-Rahmani suggests that the market has been too sanguine, and that the outbreak will serve to underline American advantages. Growth in the U.S. is more insulated from China now than it was in the growth scare that followed the 2015 Chinese devaluation, and financial conditions are easier now.

Taking all this into account, Mossavar-Rahmani argues that U.S. equities are fair value compared to equities in the rest of the world. I have argued against this over the years, and American stocks have continued to perform better, so I give this case due deference.

Here are some more Goldman-hued pearls of wisdom:

Don’t worry about fund flows

The long U.S. equity bull market is definitely not about the weight of money from investors, at least as viewed through the prism of mutual funds and exchange-traded funds. Throughout the post-crisis era they have poured money into bonds and, to a lesser extent, emerging markets and non-U.S. developed equities, while pulling money out of the American stock market:

relates to Doubting America Can Cost You a Lot of Money

Way back in the late 1990s, when the U.S. Baby Boomers were into their fifties and beginning to pour money into mutual funds to save for retirement, many of us used to look at the inflows into equity mutual funds with deep anxiety. The fear was that investors might lose interest, or panic at the first sign of trouble, and pull money out, causing a bear market or a crash. We need not have worried. Throughout the crisis, investors have churned far more money into bonds than stocks, and the equity bull market has roared on regardless:

relates to Doubting America Can Cost You a Lot of Money

Yes, central banks should spark the manufacturers back to life

Entering the year, it was a popular call that the global manufacturing slowdown had hit bottom, and that a rebound would soon start. Some awful numbers out of the euro zone, plus the deus ex machina of the coronavirus from Wuhan, have made that look silly. But the weight of central banks cutting last year meant that it looked a safe bet that manufacturing would soon recover, as this chart shows. Viruses may yet get the better of central bankers, but as it stands, it is probably best not to fight the Fed (and many other central banks); a manufacturing recovery, viruses permitting, is likely:

relates to Doubting America Can Cost You a Lot of Money

Mean reversion, shmean reversion

Mean reversion is a basic and important notion of investment. When any given metric moves a long way from its historical norm, you have a choice between predicting that it will revert to the mean over time, or saying “it’s different this time.” But in real time, betting on mean reversion could still have deprived us of a lot of money over the last few decades. This chart shows returns made after entering the ninth and tenth deciles of valuation in the late 1990s bull markets, and in the current one. Mean reversion can take a long time to happen, while you sit and watch in horror at all the money you might have made. 

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U.S. stocks are expensive but not in a bubble

I agree with this particular insight, although I am nervous about how far we should take it. It is a good idea to start taking profits toward the top of a bull market, just as it is also a good idea to get out quick before a bubble bursts. But the basic point of Goldman’s graphic is sound. On almost any sensible measure, the U.S. stock market does look expensive compared to historic norms, but it doesn’t look as expensive as it did at the top of the dot-com bubble. (Interestingly, Robert Shiller’s cyclically adjusted price-earnings multiple, or CAPE, much maligned as an outlier showing that the market is too expensive for much of this rally, now suggests that stocks aren't as overvalued as other metrics show). 

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Angry Men

Having established that the U.S. remains preeminent, why does the country still seem to be simmering with anger? We know that the U.S., to a greater extent than many other countries, is stricken with deep inequality that leads to a sense of injustice. But perhaps that persistent sense of injustice is driven primarily by issues of gender. 

In an interesting study, the Institute of International Finance shows that employment rates for the prime working age populations are improving throughout Europe and the U.S. — although on this measure, perhaps surprisingly, the U.S. is less impressive than Germany, France, the U.K., and even Portugal:

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But this is driven by significant increases in the number of women joining the labor force, or making themselves available for work, across the developed world. This trend is universal, but perhaps least marked in the U.S.:

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Meanwhile male employment in the U.S. is still slightly below its pre-crisis levels. The nations of peripheral Europe have far greater male unemployment, but have at least registered sharp improvements after a savage recession:

relates to Doubting America Can Cost You a Lot of Money

Perhaps most significantly, labor force participation rates show that American men are increasingly giving up on looking for work, even when they are in the prime working age bracket from 25 to 54. The U.S. male participation rate is roughly as low as in Italy, which hasn’t enjoyed a decade-long economic expansion. Male participation is far higher in the rest of Europe.

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Male voices have a way of making themselves heard. And the American male unemployment problem is real, and persists a decade after the crisis. That probably plays a big part in maintaining the high levels of anger and grievance in the U.S. body politic. 

 

Adios for Now

Points of Return is taking a week’s vacation. Expect the next one in your inbox on Feb. 25.

 

  1. Named after Facebook Inc., Apple Inc. Amazon.com Inc., Netflix Inc. and Google's owner Alphabet Inc.

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John Authers at jauthers@bloomberg.net

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