USA vs. ex-USA

The US market has outperformed the non-US market for a number of perfectly rational reasons. Firstly, the earnings power of large US companies, their global reach and their leading role in technological innovation were key drivers of this outperformance. US companies, particularly in the technology sector, have capitalized on major growth trends such as artificial intelligence, making them even more attractive to global investors. The "Magnificent 7", including giants such as Apple, Microsoft and Nvidia, captured a disproportionate share of investment flows, contributing to the rise in US indices. In addition, the US market enjoys a significant valuation premium over other markets, reflecting investor confidence in the resilience and continued growth of the US economy. This premium is justified by faster economic growth compared to regions such as Europe and Japan, although the US economy is growing at a slower pace than some developing countries. However, the relative political stability, favorable regulatory environment and high liquidity of the US market attract foreign capital, further strengthening its dominant position. The US dollar also plays a crucial role in this dynamic. Its high value relative to other currencies reinforces the attractiveness of dollar-denominated assets, attracting capital flows to the United States. This situation is accentuated by the Federal Reserve's monetary policy, which, despite facing challenges such as inflation, continues to maintain an investment-friendly environment. In addition, the US accounts for a disproportionate share of global equity indices, prompting fund managers to overweight US equities in their portfolios. This overweighting is often justified by the superior historical performance of US equities, creating a virtuous circle in which sustained demand for US equities fuels their valuation. However, this outperformance is not without risks. The high valuations of US equities, particularly in the technology sector, raise concerns about the formation of a bubble. What's more, the concentration of performance in a small number of large caps could leave the market vulnerable to corrections should these companies disappoint investor expectations. The outperformance of the US market relative to the non-US market is the result of a combination of economic, political, technological and financial factors. However, investors must remain vigilant to the potential risks associated with high valuations and excessive concentration of performance in a limited number of companies. Geographic and sector diversification may be the best way to mitigate these risks and seize opportunities in other global markets.

The GSV (Global Small Value) vs. ULG (USA Large Growth) triptych

Small caps vs. big caps

Small caps have underperformed big caps over the past three years, and there are several reasons for this trend. Firstly, large technology companies, often classified as big caps, have attracted a disproportionate amount of investor attention, particularly with the rise of artificial intelligence. The behemoths of the technology sector, dubbed the "Magnificent 7", have captured a significant share of investment flows, leaving small caps in the shadows. This concentration on large technology stocks was exacerbated by the perception of these companies as safe investments, combining growth, profitability and stability. Secondly, the cost of capital played a crucial role. Small caps, generally more indebted than their larger counterparts, suffered from rising interest rates. Indeed, a significant proportion of their debt is at variable rates, making them particularly vulnerable to rate fluctuations. By way of comparison, around 45% of small caps' debt is at variable rates, compared to just 9% for S&P 500 companies. This has weighed on their performance, as higher borrowing costs have reduced their ability to invest and grow. In addition, the macroeconomic environment favored large caps. Trade tensions, particularly between the United States and Europe, created a climate of uncertainty that prompted investors to favor assets perceived as safer, often associated with large companies. Protectionist policies, such as those being considered by the Trump administration, have also accentuated this trend, as large companies generally have a greater capacity to adapt in the face of regulatory change. In addition, ongoing deglobalization has had mixed effects. While it has enabled some small caps, which are more oriented towards local markets, to benefit from the relocation of supply chains, it has also limited their access to larger international markets, thus curbing their growth potential. However, this underperformance of small caps could present investment opportunities. Historically, periods of prolonged small-cap underperformance have often been followed by significant rebounds. The interest rate cuts envisaged by the Federal Reserve could also ease the debt burden of small caps, making them more attractive. What's more, small caps are currently trading at a significant discount to big caps, which could attract investors looking for undervalued stocks. Finally, small caps offer welcome diversification in a portfolio often dominated by large technology stocks. Their growth potential, though riskier, remains attractive, especially at a time when valuations of large companies are reaching historically high levels. Wise investors could therefore consider rebalancing their portfolios to include more small caps, betting on a potential comeback of these stocks thanks to a change in the economic cycle.

Projected relative valuation in terms of P/E ratio between US big caps (S&P 500), mid caps (S&P 400) and small caps (S&P 600)

Projected relative valuation in terms of P/E ratio between big caps (S&P 500) versus mid caps (S&P 400) and US small caps (S&P 600).

Growth vs. value

The value style has underperformed the growth style (particularly in the US) over the past decade, for several reasons. Firstly, the rise of large technology companies has played a central role. These companies, often classified as "growth", have enjoyed rapid revenue and earnings growth, attracting considerable attention and investment. Behemoths such as Apple, Nvidia, Microsoft, Meta Platforms, Amazon, Tesla and Alphabet, dubbed the "Magnificent 7", saw their valuations soar thanks to their ability to combine innovation, profitability and investment security. This dynamic has been accentuated by the rise of artificial intelligence, which has propelled these companies to unprecedented heights. At the same time, the value style, which focuses on companies undervalued by the market, has suffered from the perception that these companies offer less growth potential. Investors preferred to bet on companies offering more promising growth prospects, even at high valuations. This preference for "growth" was reinforced by a low interest rate environment, which favored companies capable of generating strong cash flows and financing their growth at lower cost. In addition, the COVID-19 pandemic accelerated digital transition and technology adoption, further strengthening the position of growth companies. Confining and telecommuting stimulated demand for technology products and services, accentuating the divergence between growth and value styles. Small caps, often associated with the value style, have also been eclipsed by large-cap technology stocks. Small caps, while historically outperforming over the long term, were perceived as riskier in an uncertain economic climate. Their higher debt levels and sensitivity to economic cycles deterred investors, especially in an environment where the cost of capital was crucial. Finally, the concentration of stock market performance on a small number of large companies exacerbated the underperformance of the value style. Stock market indices, heavily weighted by these technology giants, saw their overall performance boosted, masking the relative weakness of value stocks. In short, the underperformance of value stocks relative to growth stocks in the U.S. can be explained by the rise of major technology companies, a low-rate environment conducive to growth, and a concentration of stock market performance on a small number of players. For the value style to regain its strength, a paradigm shift is needed, perhaps initiated by sector rotation or a change in macroeconomic conditions, such as a rise in interest rates or a slowdown in the growth of technology giants.

S&P 500 Value vs. S&P 500 Growth projected valuation in terms of P/E ratio

Proportion of value and growth in the S&P 500

Conclusion

Ever heard of recency bias? It's the tendency of investors to overemphasize and generalize their recent experiences. Initially, these stories may be based on actual facts, but they lose their relevance once fundamentals are factored in, pushing valuations well beyond the most optimistic forecasts. The problem is that these stories become so entrenched that when fundamentals start to change (which they almost always do), investors are left clinging to an outdated vision. While US large-cap growth stocks have swept the board in recent years, there's no guarantee that they'll do the same over the next decade. Growth in the future must be as great as it was in the previous decade to merit the current valuation. Indeed, many valuation experts expect very low returns for the S&P 500 in the future, on the order of 3% per annum until 2030.

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