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Why has the US stock market performed so well? And can this continue?

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The United States is on a winning streak. Four years in a row, through political unrest and Covid-19, US stock markets have beaten the world. As we hit the second anniversary of the pandemic, investors should wonder if this can continue.

Few would have predicted it would turn out like this. The United States had the worst response to Covid in the developed world by two key measures: the highest death rate and the lowest vaccination rate. Still, U.S. stocks have yielded more than double the gains of the rest of the world since the end of 2019.

Basically, there are three ways to think about this exceptionalism of the American market.

Superior economy

The economy has certainly been a winner. Lavish government subsidies drove household incomes higher as the economy slumped in early 2020, the first time they experienced a recession, and it positioned the US as one of the best growth of all developed countries since 2019 (South Korea, Israel and Ireland have done better, but are much smaller). Economic growth has fueled earnings, and that certainly explains some of the outperformance of U.S. equity markets: earnings estimates for the year ahead are 20% higher than before the pandemic, more than double the rise in the rest of the world.

Still, US stocks are up around 50% since the end of 2019, so higher earnings are only part of it. The rest is a rise in valuation, anticipating faster earnings growth going forward. Is it reasonable? Not if the economy simply returns to its previous growth path. Not if the huge increase in public and corporate debt over the past two years is holding back future expansion, as one would expect. And not if the economy depends on government stimulus for growth, because that cannot be sustained politically or economically.

The biggest companies

The focus on large US companies may come to the aid of US bulls. Not all companies have done well. But among the global winners of the pandemic, many were in the United States, and not just in obvious areas like Zoom or video streaming.

The largest stocks of online platformsAlphabet, Microsoft,

Apple,

Amazon,

Meta Platforms (formerly Facebook) are American, and the pandemic has accelerated their growth. Along with concern about the coronavirus was concern about the environment, and the biggest winners of both are in the United States: Moderna and Pfizer due to highly profitable mRNA vaccines, and Tesla in reason for electric cars. The United States has also been at the center of the boom in initial public offerings and reverse listings via special purpose acquisition companies, or SPACs. Many of the new companies will disappoint, or have already done so, but some could become the megacap stocks of the future.

The United States has also long had a very flexible and innovative economy, despite concerns about monopoly power. If U.S. businesses are better able to adapt than their international rivals, they should be better able to cope with disruptions not only from the pandemic, but also from geopolitical, social and environmental upheavals that may occur. If true, it would warrant a higher valuation.

Likewise, the United States has historically accepted more creative destruction than other major countries, adapting more quickly after a crisis. While state support has prevented many corporate bankruptcies over the past two years, the US market is generally quick to reallocate capital from past winners to chase potential future successes, helping the market capture new trends faster than many others.

However, the United States has not always been so exceptional, which undermines the argument. From 1950 to 2010, US stocks earned 6.9% a year above inflation, including dividends, while the rest of the world earned 7.6%, according to market historians Elroy Dimson, Paul Marsh and Mike Staunton (composed, that little difference becomes huge). It is only since 2010 that the situation has been reversed, with Europe in crisis and the United States driven by Big Tech stocks. Recent American dominance may continue, especially with today’s giants spending so much on research and development, but history is not favorable.

Rather than the biggest companies, the risk is that the United States simply has a market dominated by companies that profit more from low interest rates. Big Tech valuations soared on exceptional support from the Federal Reserve and falling bond yields. If a stronger economy leads to higher bond yields, expected future earnings could be worth less than they are today and US equities could suffer even if growth continues, contrary to what usually happens.

An Apple store in Beijing. The pandemic has accelerated the growth of Apple and the other largest online platform stocks, which are American.


Photo:

Roman Pilipey/Shutterstock

It’s all just speculation

The truly bearish approach is to say that all of these attempts to find a story over the past two years are missing the real point, which was the rise in speculation. The significant change in the structure of the stock market was the arrival of millions of individuals filled with stimulus checks and having free time to gamble.

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Stephen King, senior economic adviser at HSBC and author of Grave New World, points out that in the late 1980s many strategists believed that the success of Japan’s industrial model explained Japan’s stock market excess. But they discovered it was just another bubble, he says. The country’s stocks are still well below their 1989 peak.

I remain hopeful that the foam is not indicative of irrational inflation in the broader market. I prefer to explain the US lead by the first two reasons: the surprising nature of its economic recovery and earnings, combined with a sharp rise in valuations due to falling bond yields.

They were great things to have, but they are a thing of the past. I expect the end of the pandemic to contribute to economic growth, allowing bond yields to maintain their early 2022 gains and perhaps rise further, a headwind for the gigantic stocks that dominate the market. American. This will slow the US, even as cheaper, more cycle-sensitive stocks should be able to avoid the pain of higher yields. Since there are more elsewhere, this should give overseas markets a chance to get ahead. In other words: as Covid recedes, so should American exceptionalism, at least in the stock market.

Mr. Mackintosh is a senior markets columnist for the Wall Street Journal in London. Email him at [email protected]

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