Why One Foreigner Expects the U.S. to Reclaim Its Stock-Market Dominance

Understanding Recent Underperformance of U.S. Stocks

As the financial world observes the unfolding of the nonfarm payrolls report on a job-focused Friday, a historical pattern emerges from the past easing cycles of the Federal Reserve. These cycles have traditionally been linked with enhanced returns for U.S. equities, but current circumstances tell a different story. Hubert de Barochez, a senior markets economist at Capital Economics, emphasizes the unique underperformance of the U.S. stock market in recent months. Since mid-June, the MSCI USA index has generated a mere 5% return—half that of global equities excluding the U.S., as represented by the ACWX index in dollar terms.

The Four Key Factors Influencing U.S. Market Performance

De Barochez outlines four pivotal reasons for the current underperformance of the U.S. equity market:

1. Technology Sector Vulnerability

The first factor centers on the technology sector, which holds a significant share in the U.S. market. Although there has been a minor recent rebound, technology stocks in the U.S. have declined more sharply than those in other parts of the world. De Barochez notes that concerns over an economic slowdown have led investors to question the sustainability of earnings growth for these tech giants—many of which were previously “priced for perfection.”

2. Low Exposure to Financial Stocks

The second factor is the relatively limited exposure of the U.S. market to financial stocks, which have been enjoying a rally due to a steepening yield curve. This shift is expected to enhance the interest margins for banks, especially as investors anticipate a soft economic landing. In contrast, financial stocks account for only 13% of the U.S. index, compared to 22% for the global index outside the U.S.

3. Depreciation of the U.S. Dollar

The third factor at play is the depreciation of the U.S. dollar, which has fallen over 3% since mid-June. This decline has positively impacted returns from equities outside the U.S. in constant currency terms. De Barochez illustrates this point with the example of the Japanese stock market, where a near 8% increase in the yen against the dollar turned a modest drop in the MSCI Japan Total Return Index into a nearly 7% gain in U.S. dollar terms.

4. Surge in Chinese Equities

Lastly, the U.S. market’s underperformance has been partly fueled by the impressive rebound in Chinese shares. The MSCI China index has surged nearly 30% in dollar terms since mid-June, driven by substantial stimulus measures from the Chinese government. These dynamics have led to significant capital inflows into Chinese equities, overshadowing those in the U.S.

The Future: Potential Return of U.S. Market Dominance

Despite these challenges, De Barochez holds a bullish outlook for the U.S. market’s potential to resurge. He believes that past easing cycles of the Federal Reserve typically correlate with superior returns for U.S. equities compared to their global counterparts. Furthermore, De Barochez posits that the fervor surrounding artificial intelligence (AI) could spark a new wave of investor enthusiasm, resulting in significant boosts to equity valuations.

The AI Factor: A Double-Edged Sword

AI continues to generate excitement among investors, primarily driven by the strong profits from technology companies and soaring expectations for future growth. De Barochez cautions, however, that if the market’s current enthusiasm for AI leads to conditions reminiscent of the dotcom bubble, the potential for a significant setback looms on the horizon. He warns that if such a bubble bursts in 2026, U.S. stocks could be disproportionately affected.

Conclusion: A Complex Outlook Ahead

In summary, while the U.S. stock market has faced a period of underperformance due to sector vulnerabilities and external economic conditions, a combination of historical precedent and market dynamics surrounding AI could pave the way for a recovery. Investors must remain vigilant and adaptive to the evolving landscape as they navigate these uncertain, yet potentially rewarding, times in the financial markets. The interplay between domestic developments and global trends will ultimately shape the future trajectory of U.S. equities.