After a decade of U.S. stock dominance, prospects look brighter in non-U.S. markets.
As markets churn—and with global bank stocks especially hard hit in the wake of the biggest U.S. bank collapse since 2008—it’s not easy to see clearly ahead. Countervailing forces will impact the prospects for growth and inflation, and in turn the potential for investment returns in 2023.
When we step back from the day-to-day market volatility, one theme continues to resonate: The outlook for economic growth outside the United States is brighter than seemed possible just six months ago. China is quickly reopening post-COVID. The euro area economy avoided a recession this winter thanks to a resilient energy sector.
Yet, your portfolio, like many investor portfolios, may be overloaded with U.S. stocks after a decade of outpacing their foreign counterparts.
We think it’s a good time to look beyond U.S. markets and focus in particular on Chinese and European equities. Here, we explore five reasons (home country bias, stronger economic growth, higher profits, better valuations, secular trends) why you may want to broaden your investment horizon this year.
Beware of home country bias
Many investors stick to their home countries in making investment decisions. For example, the U.S. equity market accounts for more than half of the global stock market, yet nearly three-fourths of the entire U.S. equity market is owned by Americans.
Home country bias may have proven helpful to U.S. investors during the past decade, as the U.S. stock market was propelled higher by the growth of mega-cap tech companies. However, such a bias may be problematic if U.S. stocks were to underperform. Looking ahead, we see several reasons why U.S. stocks might lag their global peers this year.
Look for greener growth pastures
For much of 2022, Beijing’s zero-COVID policy kept China under lockdown. Europe, following Russia’s invasion of Ukraine, faced an energy crisis and a seemingly inevitable recession. But by the end of the year, dynamics for both regions had dramatically shifted.
China has reopened much faster than expected, and economic activity is recovering across sectors. In February, manufacturing activity expanded at its fastest pace in a decade. We believe consumers will continue to fuel growth as they start to draw on excess savings amassed under lockdown. Even the long-troubled property sector shows signs of hitting bottom. Finally, the Chinese government has made it clear that it will prioritize pro-growth policies.
In Europe, a determined effort to rebuild natural gas reserves, coupled with a mild winter, helped natural gas prices fall by over 80%, back to pre-war levels. Lower energy prices have delivered a critical boost to the euro area economy.
Of course, the coast isn’t perfectly clear. Inflation remains high in the euro area, and the European Central Bank (ECB) is still on the offensive, having recently raised the policy rate by 50 basis points (bps). Lending standards may tighten and act to slow growth as the recent bank shock reverberates globally.
Critically, though, Europe’s banks are generally on sound footing. Deposit bases are more retail-based (i.e., stickier) than their U.S. counterparts. More stringent regulations enacted in the wake of the financial crisis and eurozone sovereign debt crisis strengthened capital ratios. And finally, European banks’ riskier securities portfolios tend to be smaller than their U.S. peers.
Growth in major economies is re-emerging
This chart measures the time series of Composite PMI for U.S., China, and Eurozone since April 2020 through February 2023. The U.S. came in at 27 in April 2020 and later rose up to a peak of 68.7 in May 2021. It then slowly trended downwards until it bottomed at 44.6 in August 2022 and fluctuated near the same level since then. The latest value is from February 2023, which prints at 50.1. China's Composite PMI originally came in at 47.6 in April 2020 and came up to a peak at 57.5 in November 2020. Then it went down and bottomed at 37.2 in April 2022 and came back up to 55.3 in June 2022, and fluctuated near the same level since to reach the final data point of 54.2 in February 2023. Eurozone, originally came in at 13.6 in April 2020 and skyrocketed to 54.9 in July 2020. Then it trended lower to 45.3 in November 2020 before it went back up to a new peak at 60.2 in July 2021. Afterwards, it went on a downward path until it reached 47.3 in October 2022 before bouncing back to the most recent data at 52 in February 2023.
As a whole, the financial sector is well capitalized
This chart shows regulatory Tier 1 capital to risk-weighted assets (%) in 2009 and 2022 by country: • Italy: 8.3% in 2009 and 16.1% in 2022 • Spain: 9.3% in 2009 and 14.5% in 2022 • France: 10.2% in 2009 and 16.4% in 2022 • Germany: 10.8% in 2009 and 16.6% in 2022 • United States: 11.5% in 2009 and 13.5% in 2022 • United Kingdom: 11.6% in 2009 and 17.6% in 2022.
Uncover more resilient corporate earnings
Better growth should boost sales for Chinese and European companies, potentially leading to higher corporate profits.
Expectations for corporate profits in China only recent hit a bottom, and they have started to shift higher as companies benefit from reopening.
In Europe, corporate profits have already moved higher. Many banks reported strong earnings last quarter, boosted by higher interest rates after over a decade of negative interest rates. Lower gas prices bolstered industrial companies, energy companies are increasing their capital spending, and luxury brands seem to be going from strength to strength.
Continued scrutiny of the banking sector may add some pressure to profits (financials make up 17% of the European stock market). But European companies should increasingly benefit from China’s rapid reopening: While Asia accounted for only ~11% of Stoxx Europe 600 revenues in 2010, the region now represents more than 20%. That could be a boon for luxury companies in particular.
The Asian market accounts for a meaningful share of European corporate revenues
This pie chart shows Stoxx Europe 600's revenue exposure by region. Europe: 47% Americas: 28% Asia Pacific: 21% (up from 11% in 2010) Middle East & Africa: 4%
Beyond the sell-off
U.S. stocks, particularly mega-cap tech names, still trade at stretched valuations. At the same time, European and Chinese stocks offer more attractive price-earnings multiples. Chinese and European stocks have both sold off in recent weeks, offering a potentially attractive entry point.
Better value might be found beyond U.S. large cap stocks
This chart depicts the 5th Percentile, interquartile range, and 95th percentile of the Price-to-Earnings ratios for stocks of different categories and geographies since 2003. For U.S. Large Cap, the 5th percentile PE came in at 11.9, the interquartile range goes from 14.0 to 17.5 with the median at 15.7. The 95th percentile is at 21.4. The current value for U.S. Large Cap stands at 18.1, which is slightly above the interquartile range. For U.S. Tech, the 5th percentile PE came in at 13.0, the interquartile range goes from 16.5 to 23.0 with the median at 19.0. The 95th percentile is at 28.5. The current value for U.S. Tech stands at 23.0. For U.S. Mid Cap, the 5th percentile PE came in at 12.2, the interquartile range goes from 15.0 to 18.1 with the median at 16.7. The 95th percentile is at 20.5. The current value for U.S. Mid Cap stands at 14.9. For U.S. Small Cap, the 5th percentile PE came in at 12.5, the interquartile range goes from 18.4 to 24.1 with the median at 21.6. The 95th percentile is at 32.8. The current value for U.S. Small Cap stands at 23.1. For Europe, the 5th percentile PE came in at 9.6, the interquartile range goes from 11.7 to 14.8 with the median at 13.5. The 95th percentile is at 17.1. The current value for Europe stands at 13.1. For France, the 5th percentile PE came in at 8.8, the interquartile range goes from 10.9 to 14.1 with the median at 12.9. The 95th percentile is at 17.0. The current value for France stands at 12.8. For UK, the 5th percentile PE came in at 9.1, the interquartile range goes from 10.7 to 13.6 with the median at 12.4. The 95th percentile is at 15.6. The current value for UK stands at 10.7. For Emerging Markets, the 5th percentile PE came in at 8.5, the interquartile range goes from 9.7 to 11.7 with the median at 10.7. The 95th percentile is at 13.6. The current value for Emerging Markets stands at 11.4. For China Onshore, the 5th percentile PE came in at 8.8, the interquartile range goes from 10.8 to 14.4 with the median at 12.5. The 95th percentile is at 24.7. The current value for China Onshore stands at 11.7. For China Offshore, the 5th percentile PE came in at 9.4, the interquartile range goes from 10.2 to 11.5 with the median at 10.7. The 95th percentile is at 12.6. The current value for China Offshore stands at 9.5.
Buy tomorrow’s trends today
China and Europe both may play critical roles in shaping some of the most powerful trends driving the global economy in the coming years, including:
- Deglobalization
- Supply-chain resiliency
- Energy and food security
- Decarbonization
The European Union looks poised to embark on several new initiatives to bolster the energy transition. As policymakers and companies focus on decarbonization and energy security, Europe’s stock market could benefit from its relatively high weighting to the industrials, materials and energy sectors compared to the U.S. market.
At their annual “Two Sessions” conference in March, Chinese policymakers discussed a broad economic agenda. They emphasized the need for measures to develop high-end manufacturing. and “whole nation” efforts to achieve technological self-reliance.
Weighing all risks and rewards
Banking sector turmoil and today’s geopolitics—including war in Ukraine and ongoing tensions between the United States and China—present a risk for all investors. The prospect of slowing growth and sticky inflation also challenges central bankers across the global economy. We may well see rising market volatility as investors weigh these ongoing risks.
If volatility does increase, we believe individual stock selection (also known as active management) will be even more essential to identify high-quality companies able to ride out the market storms, as well as those that offer access to future growth trends. Stock benchmarks in Europe and China are also less concentrated than large-cap U.S. indices, giving active managers a better chance to outperform the index.
We can help
Your J.P. Morgan team can help discuss how you might be able to take advantage of the shifts in global stock markets to support your investment goals.
