S&P 500 Beating World Means It’s Time to Go Global

By Lu Wang

Photographer: Daniel Acker/Bloomberg

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This year’s record-setting rally in U.S. stocks is good news for the rest of the world.
Pushed higher as momentum builds in the American economy, the Standard & Poor’s 500 Index (SPX) has advanced 12 percent in 2014, compared with a dollar-denominated decline of 6.5 percent for equities everywhere else. The divergence, a consequence of rising stocks and a strengthening currency, is the widest for any year since 1992, data compiled by Bloomberg show.
At a time when emerging-market equities have lost more than one tenth of their value in three months and debt crises from Russia to Venezuela recall the shocks of 1998, gains in U.S. shares are a reason for global optimism. History shows that every time the gap
between America and the rest of the world got this wide, the other countries caught up in the next 12 months.
“It’s really the strength in the U.S. that contains these global issues more than anything else,” said David Lafferty, who helps oversee $894 billion as the chief market strategist for Natixis Global Asset Management in Boston. “If the U.S. weren’t accelerating, people would be much more worried and volatility would be much higher.”
There have been four other instances since 1970 when the S&P 500 ran away from international equities at the rate it is today. Each time, the MSCI World ex-U.S. Index climbed the next year, beating the the U.S. gauge by an average 14 percent.
Futures on the S&P 500 rose 0.2 percent at 10:16 a.m. in London today.

Past Divergence

In 1992, U.S. shares rose while international stocks lost 14 percent, as the dollar rallied on the pound’s exit from Europe’s system of linked exchange rates under attack by George Soros. The next year, the MSCI ex-U.S. index jumped 30 percent, more than four times the S&P 500’s gain.
The Latin American debt crisis in 1982 prompted investors to seek safety in American stocks as the S&P 500 climbed 15 percent. The MSCI measure fell 4.2 percent that year, only to rebound 21 percent in 1983.
Stocks in the U.S. surged last week as a pledge from the Federal Reserve to be patient on interest rates halted a seven-day retreat and spurred the biggest rally since 2011. The S&P 500 had tumbled 5 percent since Dec. 5 as oil’s plunge spurred concern that companies would cancel investments and emergency actions by Russia failed to stop the ruble’s slide.
In a year where collapses in crude and currencies roiled emerging markets from Venezuela to Malaysia, Japan slipped into a recession and Europe teetered on the brink of its own contraction, American shares have closed at records 49 times.

Growth Engine

More than $1 trillion has been added to U.S. equity values in 2014, lifting the global market capitalization to an all-time high of $66.5 trillion in September. Gains from health-care and technology shares have offset losses in commodities, with American companies such as Apple Inc. (AAPL) and Johnson & Johnson jumping at least 15 percent.
“The U.S. has been the locomotive pulling the global economy forward,” Sam Wardwell, a strategist at Pioneer Investment Management Inc. in Boston, said by phone. His firm manages about $250 billion. “Profit growth is solid. Economic optimism is rising. The U.S. doesn’t need the rest of the world nearly as much as the world needs the U.S.”
Growth in the world’s largest economy is picking up. Last month, American employers hired more people than at any time in almost three years and the breadth of industries adding jobs was the broadest since 1998. Economists surveyed by Bloomberg forecast a 3 percent expansion in gross domestic product next year, the fastest in a decade.

Monetary Policies

Prospects elsewhere are less promising. In Asia, China’s economy is on course to grow the least since 1990 this year and Japan just fell into its fourth recession since 2008. European inflation was 0.3 percent in November, compared with the European Central Bank’s goal of just under 2 percent, and is poised to turn negative because of a slump in oil prices.
While the Fed prepares to raise interest rates, central banks in Japan and Europe are expected by economists to add monetary stimulus.
“The U.S. looks better,” said Jim McDonald, the chief investment strategist at Chicago-based Northern Trust Corp., which oversees $920 billion. “If the U.S. economy does show continued growth, then that gives some support to the fact that central bank policies can repair the economy.”
Excluding the U.S., the world’s 45 other largest stock markets have increased an average 4.9 percent this year in local currency terms, less than half the S&P 500’s advance, data compiled by Bloomberg show.

Market Breadth

The majority of them have yet to recoup their losses from the financial crisis. One third of the benchmark indexes are trading below previous peaks and five of them, all in Europe, are still down at least 50 percent. While China’s Shanghai Composite Index (SHCOMP) is posting the best return in 2014, jumping 47 percent, the gauge has only made up about half of its 72 percent loss between 2007 and 2008.
The lack of market breadth reflects a shortage of growth worldwide and the turmoil in Russia and oil highlights the fragility of the financial market, said Hank Herrmann, the Overland Park, Kansas-based chief executive officer of Waddell & Reed Investment Management Co.
Over the nine days through Dec. 16, Russia’s dollar-denominated RTS Index (RTSI$) lost a third of its value as the ruble sank to a record. Venezuelan bonds plunged below 40 cents on the dollar, while an index tracking 20 emerging-market currencies fell to the lowest level in more than a decade. The slide prompted Bank Indonesia to intervene and stem a retreat in the rupiah.

Falling Crude

All of it started with falling oil, the same catalyst that triggered the 1998 financial crisis. That year, the MSCI Emerging Markets Index tumbled 28 percent as Russia defaulted and devalued its currency. In 2014, with crude prices plunging more than 40 percent and the dollar up 10 percent, the equity gauge has fallen 5.8 percent.
“There are enough serious things going on that I don’t think we’ve resolved,” Herrmann, whose firm manages $135 billion, said by phone. “The reality is our economy is the only one that has the meaningful growth. We will grow, but not vigorously,” he said. “I don’t think we’re out of the woods.”
Money is flooding to the U.S. as the dollar rose in anticipation of higher interest rates. While a stronger U.S. currency makes other nations’ assets less attractive, it will boost exports to the U.S., allowing its trading partners to benefit from a pickup in American spending, according to David Kelly, the New York-based chief global strategist at JPMorgan Funds. His firm oversees about $500 billion.

Strategist Forecasts

In 2015, the S&P 500 will advance 7.5 percent from last week’s close, according to the average estimate of 17 strategists in a Bloomberg survey. European shares are expected to climb 14 percent, while in Asia, South Korea’s Kospi index is likely to gain 13 percent, separate surveys showed. For Japanese shares, strategists predicted the benchmark Topix index will rise 6.9 percent by June.
“A lot of investors have always underestimated just how powerful and innovative the U.S. economy is and how much flexibility and mobility it has to adjust,” said Doug Foreman, who helps oversee about $9 billion as chief investment officer at Kayne Anderson Rudnick Investment Management in Los Angeles. “Concerns about people being over-exposed to Russia or energy can always happen and trigger some short-term chaos, but they never last.”