In Addition to Fundamentals and a Solid Outlook, a Number of Structural Biases Are Driving US Equities Higher

US markets continued to outperform in the final quarter of 2024. The S&P 500 has risen by 5.8% since November 1st and is approaching 60 all-time highs in one year, something that has only happened four times since 1928. At the same time, the Stoxx Europe 600 rose just 1.4% in euros and was negative in dollar terms. Investors have continued to support this trend in favour of US equities, which maintain stronger earnings growth potential compared to other geographical regions.

On the other hand, if we look at these same indices since the day after Donald Trump's election, European markets have recovered well, with an almost similar performance. This is all the more remarkable when we consider the hopes for increased productivity and efficiency raised by the Trump/Musk duo on the US markets and the political difficulties in France, in particular. However, this performance in Europe can be attributed almost exclusively to Germany and its DAX index, which has rebounded by almost 6% since November 27th, with 90% of the index's component stocks posting positive performances, as investors are already anticipating the 'post-Scholz' era and, in particular, the end of the current budgetary orthodoxy.

Despite this, the performance of European equities appears to be a minor afterthought amid the enthusiasm for US equities, which has intensified in 2024. Looking beyond solid fundamentals, how can we explain such a rise in valuations on US markets?

According to the theory of price evolution, an increase in the price of an asset requires greater demand than supply, i.e. more buyers than sellers. In this respect, capital flows into US equity funds have amounted to more than $140 billion since the US Presidential   election, bringing the total to more than $450 billion for 2024. Some sources put the figure for US Equity ETF inflows at over $1,000 billion, compared with $600 billion in 2022 and 2023, with an all-time high in November. These figures all reveal the same trend: the majority of equity flows are destined for the United States, which seems to be benefiting from a TINA effect ("There Is No Alternative").

Are investors overly naive or optimistic about the real ability of President Donald Trump, assisted by Elon Musk, to deregulate the economy, cut taxes and bring to the US as a whole, the efficiency and success that Musk has achieved with Tesla and SpaceX?

Behind these impressive fund flows lie certain explanations linked to the composition of global indices, the biases induced by passive management and the new ways in which stock market information is disseminated.

Investors' attraction to US equities has been strengthened by the many years of low interest rates, during which yield-seeking investors favoured these assets, which benefited from mass enthusiasm, linked among other things to the dynamism of the technology sector. Active fund managers have gradually increased their positions in US equities in order to keep pace with global indices. Even hedge funds have succumbed to this craze, as in the post-crisis period of 2008, when equity markets were rising by 15% a year, and even long-short funds quickly adopted a long-only strategy to avoid falling behind. As for the funds that gambled that the valuation of European equities would converge with that of their US counterparts, their performance was ultimately disappointing. This may have led disappointed investors to turn to passive solutions, with the result that passive funds now account for more than half of global asset management.

Now, this switch to passive management has de facto strengthened flows into US equities, which now account for almost 74% of the MSCI World. For every dollar invested passively, three quarters is invested in US equities, and in particular in blue chips, which have a significant weighting in the major indices.

Finally, new ways of accessing financial information subtly reinforce the bias towards momentum, in this case US equities. Some traders in the early 2000s summed up the sector in this phrase: Finance is just a flow of information! In this never-ending stream of financial information, it remains to identify those that have real predictive or explanatory value, in order to make sound investment decisions and capture market trends.

The improvement in market efficiency, defined by simultaneous access to information by all market participants, has paradoxically reinforced the effects of 'fads' when an investment conviction, however irrational, is shared on a large scale and instantaneously by many players. This is evidenced by the impact we saw in 2021 on "memes stocks", where forgotten stocks such as Nokia or Blackberry were suddenly the subject of tens of thousands of simultaneous buy orders. At that time, there was no fundamental justification for the flow, and the rise in the share price was simply the result of irrational collective decisions. Today, this mimicry is taking hold of the major listed companies, such as Broadcom, already recommended as a buy by 90% of analysts, which until last week had a market capitalization of $800 Billion. The stock, which the consensus views as the next Nvidia, published a positive outlook and then subsequently benefited from simultaneous mass buying, allowing it to soar by 25% in a single session.

Ultimately, the performance of the financial markets remains more rationally, a reflection of the dynamism of its economy. It has to be said that Europe's GDP per capita has been stagnating since 2010, and that US productivity has grown by almost 40% over the last twenty years, while it has risen by just 13% in Europe over the same period. The reality is that the 'mean reversion' for European financial markets might not exist in the long term. We have certainly seen periods of outperformance, mainly due to the high volatility of the US market and specific events favouring sectors that are better represented in European indices, but over the long term, the outperformance of the US markets remains significant.

Therefore, consensus decisions are sometimes fundamentally justified, and when they are, as we believe to be the case for US large caps, it is generally preferable not to swim against the current.

Indeed, this situation is widening the valuation gap between large and small caps, which is now at levels not seen since the tech bubble of 2000. It strengthens growth stocks at the expense of value, which is desperately biding its time, and consolidating the gap between 'expensive' and 'cheap' stocks. This makes certain stocks, overlooked by the current frenzy increasingly attractive, but only on one condition: that they find a catalyst.

It is therefore very likely that the first quarter of 2025 will continue to be favourable for the US equity markets, especially for large caps, given the uninterrupted flow into these stocks. However, the second half of the year could see a return to reality and fundamentals after the moment of truth for the new US administration. The "MAGA dream" could collide with reality, while the forgotten TINA countries, Europe and China could see a resurgence of the favourable measures enacted by their governments in 2025.

Nicolas Bickel | Group Head of Investment Private Banking