I’d gladly lose me to find you

I’d gladly give up all I have

To find you, I’d suffer anything and be glad

I’ll pay any price just to get you

I’d work all my life, and I will

To win you, I’d stand naked, stoned and stabbed

I call that a bargain

The best I ever had

— Bargain by The Who

Many investors could be forgiven for believing stocks in the United States are a superior investment to their non-U.S. counterparts. Since the global financial crisis,

U.S. stocks

have not merely outperformed those of other countries; they have trounced them. Over the past 15 years, the

S&P 500

outpaced other developed market equities by a cumulative 150 per cent.

Notwithstanding this astounding outperformance, successful investing necessitates looking ahead. To assess the likelihood that U.S. stocks will continue to outperform, it is important to analyze the drivers of their past outperformance and determine the future sustainability of these drivers.

Over the past decade, U.S. companies have delivered stronger earnings growth than those in other countries. But given the degree to which their share prices have outperformed, the magnitude of their excess earnings growth is far less than one might suspect.

Over the past 10 years, U.S. company earnings have outpaced those of foreign companies by a meagre 3.8 per cent on a cumulative basis. Moreover, this excess growth was concentrated in the first part of the decade, with U.S. companies growing their earnings at the same clip as their non-U.S. peers from 2020 to 2024.

It has achieved this mediocrity due to the stellar growth of a small handful of

megacap tech stocks

. Between 2020 and 2024, the

Magnificent Six

(Tesla Inc. was not in the index at the end of 2019), which collectively represent a 32 per cent weight in the S&P 500 index, grew their earnings at an extraordinary, annualized pace of more than 20 per cent.

Given that aggregate U.S. earnings growth, which was bolstered by a handful of megacap growth companies, has been undifferentiated, it follows that most U.S. companies have been subpar versus the rest of the world from a fundamental perspective.

Despite relatively weak earnings growth from a global perspective, the non-magnificent 68 per cent of S&P 500 companies nonetheless trade at a significant premium to their non-U.S. peers. Going forward, unless these companies can produce greater earnings growth than those in other regions, their relatively elevated valuations are not fundamentally justified.

Moreover, there are several reasons to suspect that U.S. companies will fail to grow their earnings faster than those in other regions.

First, the U.S. administration’s imposition of tariffs on its trading partners will inevitably raise costs for U.S. companies and reduce the global competitiveness of goods produced in the U.S. Even in rare instances where U.S. companies are successful in passing through these increased costs to their customers, their profits will nonetheless suffer from lower volumes.

In addition, recent developments in U.S. immigration policies will reduce the supply of labour, which will hinder economic growth. And continued policy uncertainty is likely to engender a wait-and-see mode among CEOs, thereby leading to lower levels of investment.

Even if the non-magnificent majority of U.S. stocks fail to deliver the superior earnings growth that is required to justify their relatively high valuations, there is always the possibility that the magnificent minority could save the day by delivering earnings that exceed expectations.

At an aggregate valuation of 30 times forward earnings, magnificence does not come cheap. But if these companies can continue growing their earnings at their historic pace, their valuations are sufficiently reasonable to allow for strong gains in their stock prices. Conversely, if their growth reverts to less magnificent levels, the ensuing capital losses could be substantial.

One of the key drivers of the Magnificent Six’s success has been their ability to grow their earnings at a breakneck pace with far smaller amounts of investment than what has been required of past behemoths. However, they have been aggressively ramping up investment in response to the current

artificial intelligence

gold rush.

It is possible that these investments will produce strong returns, but the low-investment/high-growth dynamic that has been a key element of the Magnificent Six’s magnificence may be a thing of the past.

Given that U.S. companies have experienced similar earnings growth as their global peers, it follows that the former’s outperformance has been primarily driven by greater multiple expansion, which has resulted in U.S. price-to-earnings (P/E) ratios that currently stand in the 90th percentile of their historical range.

Relatedly, the earnings yield on U.S. stock is close to an all-time low relative to U.S. Treasury yields. In contrast, international stocks are currently valued at a historically large discount to their U.S. counterparts.

Admittedly, it is possible for valuations to become even more stretched in the short term, and timing markets perfectly is an exercise in futility. However, history strongly suggests that higher valuations foreshadow below-average returns over the medium-to-long term.

Moreover, in the absence of any compelling argument that future profit growth of U.S. vs. non-U.S. companies will be meaningfully different, the latter appears to be a relative bargain.

Notwithstanding that diversifying away from the U.S. has been a drag on portfolio returns over the past 15 years, it may nonetheless be a prudent approach in the current environment.

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Noah Solomon is chief investment officer at Outcome Metric Asset Management LP.

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