With almost a month left in 2024 it seems appropriate to take stock of what the markets have done this year. It is looking likely that the undisputed winner will yet again be the US equity market. Gaining around 26% with only 6.5% drawdown, and with 57% of days so far recording positive returns, the 2024 S&P 500 seems to be on a relentless upward path compared to other global equity benchmarks. But that wasn’t always the case in 2024. During the first quarter of the year Japan’s Nikkei 225 made gains over the S&P 500, due to a falling yen that made exports cheaper and also due to significant changes to monetary policy, with a rare rate hike in March 2024 and less restrictive yield-curve control that made the Japanese market more attractive to investors. Germany’s DAX 30 also challenged the S&P 500 on the back of a strong outlook for fundamentals, which was however due to index constituents’ sensitivity to — in that case, positive — shifts to global demand and not to slowing domestic demand.
By the end of 2024 H1 however it was clear that no-one could keep up with the US economy, and the S&P 500 moved well above the two challengers. Then in September China’s Shanghai A-share stocks came roaring up, due to pro-investor policies initiated by the government to address the ongoing structural weaknesses related to housing and credit conditions. But the Chinese index quickly lost momentum, and although it is still set to finish the year better that it started, it significantly lags behind the S&P 500.
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Looking ahead, the outperformance of US equity is set to continue, according to the forecasts of the Institutional Brokers’ Estimate System (I/B/E/S). Its 12-month-ahead price-to-earnings — the main earnings multiple, and a key valuation metric — for US equity is six times the size of the rest of the world’s (RoW). To put that into context, this latest US–RoW difference sits on the upper end of the distribution and only two more positive US–RoW differentials have been observed. But forecasts entail a degree of uncertainty, and the current, favourable valuations may prove too high and subsequently be corrected if the economic outlook was to take a turn for the worse.
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The recent US outperformance owes a lot to the high valuations earned by technology stocks, and in particular by a small group nicknamed the ‘Magnificent Seven’ which includes the likes of Nvidia, Apple and Alphabet. Notably, a similar group existed during 1997–2001, and the pattern of its collective market share tracked the boom and the burst of the dot-com bubble. The Magnificent Seven presents a pattern highly correlated to the 1997-2001 timeline — but the burst in market shares just before the 1000th day was nowhere as dramatic as in 1997–2001. That was probably due to the Seven’s very strong fundamentals, and the demand for their products that finds no match in the equivalent 2001 group. What is more, the Magnificent Seven not only broke but reversed the correlation with the old group, as their valuations rotated to an even higher market share after the 1000-day sell-off.
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Another vote of confidence in the resilience of US equity valuations is the fact that the book-to-market ratios of US banks are going from strength to strength, seemingly having weathered one of the fastest monetary hiking cycles in history and despite ongoing quantitative tightening (QT) pressures from the Fed. As Fathom described in an earlier blog in March 2024, banks act like a canary in a coal mine, picking up problems in the economy and markets before they spread more broadly. The current health of the banking sector is good news in this respect.
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Although the economy is holding well, small firms are feeling the squeeze from the interest rates on short-term loans, which remain at 15-year highs even after the Fed cut a cumulative 0.75 points since it started lowering rates in September 2024.
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There are valid hopes for an easing of the recent squeeze on small companies due to, if anything, favourable cyclical trades. The small-cap stocks of the Russell 2000 tend to surprise the market to the upside closely before or after a change of administration in the White House. The result of the recent US presidential election has already pushed small-cap valuations above expectations. There might be more to come in the form of fundamentals aided by policy interventions, and not just short-lived sentiment-based cyclical trades. Fathom’s recent Global Outlook, Winter 2024: a new dawn, a new day[1] explores the potential outcomes of policy choices by the incoming US administration, and provides an analysis of investment opportunities in Europe and Japan.
[1] A selection of charts and analysis from Fathom’s latest Global Outlook will be available to LSEG readers soon via the Chartbook.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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