Are you betting on US equity markets continuing to outperform the rest of the world?

South Africans looking to invest offshore may be tempted to invest in the US equity market because it has outperformed equity markets in the rest of the world for the past 15 years. Managing rising risks, however, may be a safer way to ensure continued growth.

On average, the US equity market has delivered 7.7 percentage points more per year in returns than the rest of the world over the past 15 years, Chris Eddy, head of multi-asset funds at 10X Investments, told the recent Meet the Managers conference held in Cape Town and Johannesburg.

This is based on the performance of the MSCI US index relative to the MSCI All Countries World Index, which shows that the US has outperformed and underperformed the rest of the world in long cycles of a decade or more since the 1970s.

In the current period of outperformance almost 90 percent of the higher return is a result of a strengthening US dollar and investors’ willingness to pay higher prices for large US companies’ shares, Eddy said.

Less than one percentage point of the 7.7 percentage point difference is a result of US companies delivering strong earnings (profits) or dividends, he said.

A lost decade ahead?

Looking to what could happen over the next decade, Eddy said if the dollar remains strong and share prices relative to earnings (valuations) remain high, the US could continue to outperform. However, the dollar appears to be at a peak relative to its long-term performance and on a purchasing power parity basis could be up to 30 percent overvalued. It could therefore weaken by this much over a decade, Eddy warned.

Investors’ willingness to continue to buy US shares at high prices could also unwind as US equity valuations are much higher than their long-term averages and averages for equity markets in other parts of the world, Eddy said.

Should valuations fall and the dollar weaken, returns from US equity markets could be six percent a year lower than those from the rest of the world over the next decade, Eddy said.

Although one quarter doesn’t make a trend, in the first quarter of this year, the US equity market started to underperform equity markets in other developed countries represented in the MSCI All Country World Index, Eddy said.

Indices are concentrated in US shares

When investing offshore, if you invest in a fund tracking S&P500 index you are investing in the top 500 companies listed in the US only. The other major market index that many global equity funds or portfolios use as a benchmark is the MSCI All Country World Index. Eddy says the exposure to US shares in this index has changed from 40 percent to 65 percent over the past 15 years with the growth of large US tech shares.

So investing in line with either of these indices means backing a view that the US’s market exceptionalism will continue, he said. Managers have different views on this.

US lead in equity markets may falter

10X is of the view that relying on the US to continue to outperform the rest of the world is risky because equity valuations are higher and the dollar stronger than long-term averages. Eddy said three potential catalysts could unwind these conditions:

• AI disruption

Following the release of China’s large language AI model DeepSeek, investors are questioning how leading US-listed AI companies will monetize the large amounts of capital they have invested in AI.

Eddy said competition typically results in companies cost cutting at a risk to their profit margins. The release of DeekSeek in January marked the start of US shares underperforming those in the rest of the world in the first quarter of this year, Eddy said.

• Trade wars

The policy shocks from US president Donald Trump’s trade tariffs make it harder for the world to do business with the US. Eddy said the US’s trading partners currently re-invest their dollars in the US’s bond and equity markets. A more isolationist policy is therefore a threat to continued US exceptionalism and a stronger dollar, he said.

• US fiscal debt

The fiscal support the government provided to companies and individuals since Covid has contributed to the strong US equity market, but opposition to the budget deficit is growing in the US and could result in this spending being cut at the expense of markets, Eddy said.

If the debt is not cut, concerns about the deficit and rising interest rates could result in investors regarding the situation to be unsustainable and demanding higher yields for US bonds at the expense of US financial markets, Eddy said.

US companies continue to innovate

Arguing at the same conference for a continuation of what he termed “US dynamism” Philip Short, portfolio manager for Flagship Asset Management, said the US will continue to produce more innovative companies than the rest of the world because it is supported by a much stronger venture capital market than that in Europe or China.

Short said US companies’ entrepreneurial success is a result of venture capitalists raising large amounts of funding for start-ups and understanding the risks. Successful start-ups eventually list, providing opportunities for managers who identify their potential.

One in six companies in the S&P 500 were backed by venture capitalists before their listings on the stock market, Short said. These companies include Microsoft, Nvidia, Apple, Google, Amazon, Netflix, Meta, Starbucks, Uber, OpenAI, Oracle, Spotify and Airbnb.

In 2023, the US had 656 unicorn businesses - 48 percent of yet-to-list start-ups valued at more than a billion dollars, he said.

Venture capitalist funders are family offices and university endowments, so the US government’s fiscal issues are not an issue, he added.

You need offshore investments

South Africans need to invest offshore to diversify their investments and to protect themselves from the depreciation of the rand.

The rand has depreciated by 5.6 percent a year over the past 40 years and the South African market represents just 0.9 percent of the market capitalisation on stock exchanges around the world, Lourens Coetzee, investment professional at Marriott told the Meet the Managers conference.

Coetzee says the average South African global equity fund returned 11 percent a year over past 10 years underperforming the 14 percent a year return from developed markets as measured by the MSCI World Index over the same period.

Managing risk

But Lourens is also wary of just tracking a global equity benchmark because of the high weightings in a handful of shares – particularly the large US technology shares known as the Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla).

Fund managers choose different ways to deal with these risks.

Marriott’s funds are actively managed and it has chosen for its global portfolios to select quality companies from around the world that are able to grow their dividends over time, Lourens said.

10X’s funds are passively managed to indices. In its multi-asset high equity fund, 10X is using an equally-weighted index for global markets that reduces its exposure to large US shares. It has combined this with an index that focuses on defensive businesses that produce reliable earnings or dividends using a dividend-based index.