US Stock Dominance Can’t Go On Forever. Unless, Of Course, It Can.

It’s been a decade to remember for US stocks but, well, the past is the past. And the only question that matters to investors is whether it can repeat that performance. Goldman Sachs recently sought to answer that question, assembling a team of experts from inside and outside the firm to weigh in on whether the winds of change might be blowing, as so many believe, for the global dominance of the US economy and its stocks. Their views are worth a read. Here’s what they said…

The average annual percentage returns of the leading stock indexes, over the past ten years. Source: Bloomberg.

AI’s likely to play in its favor.

Rebecca Patterson – a former chief investment strategist at hedge fund giant Bridgewater Associates – believes the US has a lock on the top spot. And that’s mostly because of AI.

Economic growth is the biggest engine of stock market returns. And it’s powered by two sources: the labor market and productivity. So, when productivity is supercharged – as it’s about to be by AI – it will drive economic growth and the stock market gains. And in AI technologies, the US is well and truly out in front, a dominance that Patterson says is likely to continue. That’s because the US government mostly gives free rein to massive tech firms with the resources to advance technologies – unlike, say, the Chinese government, which keeps tight controls over big business.

So those AI leaders across the tech sector will drive productivity – and therefore economic growth – first and foremost in the US. They’ll also continue to grow independently of economic growth. And because tech firms already make up a big percentage of the S&P 500 (about twice the weighting of indexes elsewhere) that too is a recipe for continued US outperformance.

The US’s growth momentum could help.

So AI’s going to power a long-term boom in productivity – and thereby economic growth. And it’s going to kick off at a time when the US economy is already looking pretty good, says Jan Hatzius, Goldman’s own chief economist and head of global investment research. He points out that the US consumer is in fine fettle right now, with wages rising faster than inflation, locked-in 30-year mortgages buffering homeowners against rising interest rates, and some pandemic savings left over. Europeans haven’t had it so good: not only are they still scraping themselves off the ground after last year’s horrendous energy-price shock, but they also don’t have the luxury of super long-term mortgage locks.

Mind you, it’s not all a bed of roses in the US. The government’s books look ropey, if not downright unsustainable. The fiscal deficit (that’s the government’s yearly spending above taxes) is running around 6.3% of the total US economy. That’s similar to levels coming out of the 2008-09 financial crisis, after a string of extra government spending aimed at getting the economy up and moving, and getting people back to work. The current deficit is happening despite the economy growing at a healthy clip and unemployment lingering around record lows. At some point, there’s going to be pressure to shrink that deficit, but any plan to do so will likely drag down the US economy.

US fiscal budgets (red) have had deeper deficits, before interest payments, than the average developed market economy (blue), and that’s expected to continue for some time. Source: Goldman Sachs.

And the shareholder-centric nature of US companies doesn’t hurt.

Now, this driver – pointed out by Goldman strategists David Kostin and Lily Calcagnini – is more about US companies just being better – from a shareholder’s perspective. US firms tend to boast profit margins and returns on equity (ROE) that are way higher than their international peers. And there’s a very good reason too. US management teams get paid mostly in stock, so they try to achieve things they know shareholders will buy into – like fatter margins and improvements in return on equity (ROE). As a result, the S&P 500 saw its ROE rise by almost 5 percentage points over the past ten years. That’s way better than anywhere else. Oh, and its starting point (15%) was considerably higher too.

Return on equity, or ROE, is a measure of how much profit a firm makes in relation to shareholder capital. Above, how it’s changed over the past ten years for the S&P 500, Europe’s STOXX 600, Japan’s Topix, and the MSCI World Asia (excluding Japan). Source: Goldman Sachs.

But some megaforces could upend the trend.

Sure, many of the business conditions that have driven US stock dominance over the past ten years are still firmly in place. But new forces are gathering strength, and Jean Boivin, the head of the BlackRock Investment Institute, says they could disrupt the whole thing.

Specifically, there are three to pay attention to. First, the American population is aging, and though it’s not exclusively a US issue, it’s something that the country’s corporations are going to have to grapple with. Second, geopolitical uncertainties are high and rising – after a long trend toward globalization that was hugely profitable for US firms. And third, there’s the transition to cleaner energy, which appears to be gaining momentum.

The three forces may throw a wrench in the works: instead of being able to crank out more and more goods and services, taking advantage of access to cheaper labor and frictionless trade, companies will be faced with a less well-oiled global machine. In other words: they may find increasing barriers to trade and tougher access to labor, goods, technology, and other things. And the result is likely to be a world with persistent inflation and higher interest rates.

Admittedly, Boivin says that the US is in the best position to navigate all this. It’s got a highly flexible economy and labor market, after all. But think of it like this: on a calm summer’s day on a perfect track, the fastest runner will always win. But on a rainy and blustery February day, an upset is more likely.

And the US economy could falter.

Yeah, the US economy’s been a juggernaut. But its run of economic growth outperformance – while good against its advanced economies peers – still fell short of most emerging markets over the past ten years. And Goldman’s Kevin Daly, head of economics for the CEEMEA region (that’s Central and Eastern Europe, Middle East, and Africa) says that could continue.

And that suggests that the odds of an emerging market snapback are probably pretty good. Like, if you keep flipping a coin and landing on heads, tails becomes more likely. Goldman’s own projections for the US and major emerging market economies show several countries on a faster growth trajectory than Uncle Sam.

Goldman Sachs’s economic growth projections over the next 50 years. Source: Goldman Sachs.

This argument is strengthened by the fact that valuations – both for US stocks and the US dollar – aren’t particularly attractive right now. And an expensive double-whammy of US stocks and US currency wouldn’t seem to bode well for future returns.

Here’s what you might take from all this.

If you ask me, one of the hardest things about investing is that for every seemingly sensible and logical argument, there’s a counter. That’s especially true with big-picture discussions like the one we’ve just walked through. But it doesn’t make consuming these views any less important. Here’s what I do when tackling topics like these…

I make sure not to make snap decisions based on the latest argument I’ve read. I also try to let these lay-of-the-land views kinda fester in my head for a while. I try to allow some time between reading and deciding, because more often than not, I’ll stumble across an opposing view that might be more convincing. And, it sounds obvious, but I also try to think for myself. That’s not always easy, especially when you’re just starting out on your investment journey, but it’s important to try to think in terms of probabilities. Which conclusion seems the most likely?

Now, if you were to ask me about the prospects for continued US dominance, I’d say it’s more likely than not to continue. I totally get the arguments of why it might not. But for me, the strongest POV is about the companies, their management teams, and that obsession with shareholder-return-friendly things like ROE. I don’t have strong views on economic growth leadership, but I do believe that there’s a better than 50% chance that US firms keep (and probably extend) their profit and return advantage over non-US firms. And that’s enough for me.