The United States or the Rest of the World?
Bryan Taylor, Chief Economist, Global Financial Data
Financial advisors recommend that you allocate your investment funds between stocks, bonds and bills and allocate a portion of your portfolio to international investments as well as domestic investments to reduce risk. Few people outside of the United States can ignore investing some portion of their portfolio in the United States. Not only does the United States represent almost 60% of global investible stocks, but the United States has consistently outperformed the rest of the world during the past century. During the past 13 years, US stocks have returned 12% per annum while stocks invested in the rest of the world have returned only 4.77%. The United States has seized on the technological changes that have occurred since the 2008 Great Financial Crisis and has delivered growth to investors. The large-cap tech stocks have led the way in outperforming the rest of the world.
But will this continue? Are American stocks overvalued and is it time to switch to non-American stocks? Or should investors continue to ride the All-American wave? What can we learn from the past to inform us about the future?
The Phases of American Performance
If you look at Figure 1, you can see a comparison of the relative performance of US stocks and non-US stocks since 1900. An increase in the value of the index signals US outperformance and a decline signals US underperformance. We can break up the relative performance of US and Global stocks into eight phases over the past 125 years.
Figure 1. United States GFD 100 Divided by GFD World x/USA Index, 1900 to 2023
Before World War I, capital could flow freely between the different countries of the world. Foreign stocks were free to list on other exchanges. Stocks and bonds paid dividends and interest in different currencies according to where the stocks and bonds were listed. Because they had deep capital markets, both Paris and London traded hundreds of stocks from different countries, and investors were free to buy shares in companies from almost any country in the world. Stock performance was similar between different countries. Low returns in stocks from one country would lead to funds being withdrawn and invested in another country. Most of the return came in the form of dividends, not capital appreciation. Consequently, up until World War I, differences between returns to the United States and other countries were small.
When World War I began, stock markets closed in most major markets, and countries put up barriers to the free flow of capital. What was once one large international market became dozens of individual national markets. Countries in Europe, especially the countries that were defeated during World War I, struggled to recover. Capital flowed to the victors, especially the United States, which loaned billions of dollars to European countries. The American economy, and especially its stock market, boomed and the US outperformed the rest of the world dramatically during the 1920s.
The Roaring Twenties, however, ended in a crash and the Dow Jones Industrial Average declined over 85% between 1929 and 1932. The Great Depression took over the American economy and investors avoided American stocks during the rest of the 1930s. The US underperformed the rest of the world until the start of World War II.
After Pearl Harbor was bombed and the United States entered the war. The US stock market staged a dramatic recovery while foreign markets sank under the pressure of the war. The United States produced the goods that the rest of the world needed. The most dramatic outperformance came in the 1940s when war, nationalizations and controls on investing limited the performance of stock markets in Europe. After World War II was over with, the stock market in every country recovered. It was the trente glorieuses in France and the Wirtschaftswunder in Germany, but the United States continued to outperform the rest of the world. Even in the 1960s, there was a final period of outperformance until the Vietnam War and stagflation slowed the American economy.
Between 1967 and 1988, American shares underperformed the rest of the world. Between Vietnam, price controls, Watergate, OPEC and stagflation, the United States fell behind. Moreover, during the 1980s, the rest of the world opened their economies to trade, stock markets and capitalism. Developed countries privatized the industries they had nationalized after World War II, and emerging markets opened their markets to the rest of the world. The Asian Tigers, Japan, Taiwan, Korea, Hong Kong and Singapore all showed rapid growth as each country promoted exports to the United States and the rest of the world.
During the 1990s, the internet and telecommunications became important parts of global commerce. Computers and biotech became sources of growth globally. At the forefront of these changes was the United States. Technology corporations developed products that were used worldwide. and this phase of the technology revolution spurred growth in US stocks, driving the ratio of the US stock market capitalization to over 100% of GDP. The dot.com boom created a bubble in the late 1990s that the United States benefited from.
Once the internet bubble burst in 2000, money flowed back into the countries that had been ignored during the 1990s, especially emerging markets, which did well until the Great Financial Crisis of 2008. Emerging markets did better than Europe and staged a large rally that global investors benefited from.
Once the Great Financial Crisis hit, however, money began to flow back into the United States and has been doing so since then. The 2010s were the decade of Apple, Alphabet, Amazon, Microsoft and Meta/Facebook. All those corporations, and now Nvidia achieved market caps of over $1 trillion and Apple has recently hit a $3 trillion market cap. The internet and telecommunications enabled these companies to provide their services throughout the world and take advantage of new technology faster than firms in other countries. But will this last?
GDP and Stock Market Capitalization
Two other ways of looking at the American stock market relative to the rest of the world is to measure US GDP as a percentage of World GDP, and US stock market capitalization as a share of World stock market capitalization.
Figure 2 shows US GDP relative to the rest of the world over the past 175 years. In 1850, the United States represented only about 5% of global GDP. Its share rose steadily to around 20% when World War I began, then increased to 40% of global GDP during the 1950s. Since the 1960s, however, the United States’ share of global GDP has shrunk. Although the United States has only 4% of the world’s population, it represented about one-third of global GDP at the beginning of the twenty-first century and over one-quarter today. You can draw a correlation between the peaks and valleys in GDP with the outperformance of the US stock market over the rest of the world in Figure 1.
Figure 2. USA GDP As a percentage of Global GDP
Figure 3 looks at US stock market capitalization relative to the rest of the world. The graph underestimates America’s share of global investing because it includes all stocks regardless of how easy it is to invest in those companies. If you limit the data to investible companies, the United States currently represents about 60 percent of the global stock market, not 40 percent as the graph suggests. This is because many shares in emerging markets, such as China, are not readily available to invest in.
Nevertheless, Figure 3 shows the trend in the United States’ share of global stock market capitalization. The trend was upward from the end of the Civil War until the 1960s. For 100 years, US stock market capitalization grew at a faster rate than the rest of the world, not only because of policies that encouraged growth in the United States, but policies in the rest of the world that discouraged growth and technological change. Eastern Europe, Russia, India and other developing countries would all have a higher standard of living today if they had not favored communism and socialism over capitalism and free markets.
Figure 3. USA Stock Market Cap as a Percentage of Global Market Cap, 1850 to 2023
Figure 4 looks at US stock market capitalization as a share of US GDP since 1800. There was virtually no change in this ratio between 1800 and 1870 when it remained around 10% of GDP. Stock markets grew in line with the rest of the economy. As railroads, oil, industrials, utilities and other industries grew in the late 1800s, stock market capitalization increased to around 60% of GDP by 1900. Surprisingly, stock market capitalization was no greater as a share of GDP in 1980 than it had been in the 1890s. There were peaks in 1914, 1929, 1937 and 1967, but wars, inflation, regulation and other restrictions on growth kept the stock market from increasing its share of GDP. During the 1980s and 1990s, however, growth in technology pushed capitalization to exceed GDP, and in 2020, it was briefly twice GDP. For many S&P 500 companies, half of their revenues come from abroad, so it is no wonder that stock market capitalization can be greater than the GDP of the United States.
Figure 4. United States Market Cap as a Percentage of GDP, 1800 to 2023
Conclusion
The question this leaves us with is where do we go from here? Is the stock market overvalued at greater than 100% of GDP, much less at 200% of GDP? Will the market fall below 100% of GDP or will 200% of GDP be the new normal? For how much longer can 4% of the world’s population produce 25% of global GDP and its stock market be equal to 60% of global investible stock markets? Is it time to bail on the United States and diversify into other countries, or should American investors continue to rely upon the United States for their returns?
Of course, to answer this question, you need to predict what the stock markets of the United States and the rest of the world will be doing in the future. Can America continue to dominate the global economy, or will its share slowly shrink as the rest of the world catches up with the United States?
If you look back at the past 175 years to determine what has enabled the United States to outperform the rest of the world, you could summarize this in one word: technology. During the late 1800s, the 1920s, 1950s, 1980s, 1990s and 2010s, the United States was a leader in technology, bringing new discoveries to the rest of the world and manufacturing new products. For America to underperform the rest of the world, something will need to change in the world and other countries will need to develop technologies that the United States does not.
There is a thirty-year cycle that drives the American stock market. The US outperformed the rest of the world in the 1890s, 1920s, 1950s, 1980s and 2010s as well as the 1990s. The US underperformed during the 1930s, 1970s and 2000s. Based upon this pattern, it shouldn’t be until the 2030s that the US once again underperforms the rest of the world.
Of course, it is impossible to predict the future. No one in 2015 would have predicted that Donald Trump would have become President. No one in 2019 could have predicted the Coronavirus Epidemic, the invasion of Ukraine, higher inflation and higher interest rates. To predict what will happen in the rest of the 2020s, much less the 2030s, is simply impossible.
Nevertheless, history shows that trends in American outperformance or underperformance relative to the rest of the world can last for a decade or more. There is usually a fundamental reason why the US outperforms or underperforms the rest of the world. We must look at the cause for the effect. Currently, there is no reason why technology should not dominate the 2020s and the United States should not continue to outperform the rest of the world, but trends can reverse quickly. When there is a change in sentiment, be prepared to change, but right now, there appears to be no reason to change a commitment to investing in the United States.
