The global events of the past month are moving fast. It might be surprising that financial markets are taking all of it in stride, so far.
The stock markets outside of the US have struggled over the past few decades. Too much debt, poor demographics, slow policy responses, and less innovation are all culprits. But a change in leadership just happened.
The UK FTSE Index and the German DAX are the two largest European markets. Both hit all-time highs this past month. France’s CAC Index is just shy of its 2024 peak.
The MSCI Europe Index came into the year at a value of $11 trillion. The concentrated Euro Stoxx 50 Index took 25 years, but it finally beat out the price highs from the year 2000.
Not to be outdone, Japan took a 35-year hiatus from its all-time highs. In 1989, it was the largest stock market in the world, above that of the US. Today, it is just under $4 trillion, or worth a little more than one of our top technology companies. It just surpassed the 1989 levels last year, though it is having a difficult time making durable highs above those made in June of 2024.
Looking at the credit markets to see if bond investors are on the same page as equity buyers can be helpful. We can see spreads are low, indicating fewer potential defaults.
High-yield corporate bond spreads are below 4% for only the second time in the last 15 years. This last occurred in 2018 for the four major markets shown below (US, Europe, Asia, and Emerging Markets).
Whether the latest outperformance against the US can continue for international markets will come down to several factors. The number one in our eyes will be if earnings can grow faster. Earnings per share growth on a relative basis has been the factor with the best tie to stock market performance. This peaked in the ten-year period ending in 2008 for international while the US outperformed sharply since.
The US market has been led by Magnificent seven companies, all of which have big profit margins and fast growth. On the other hand, less fiscal spending over the coming years could be a headwind for US earnings. In addition, the concentration of US markets in a handful of technology companies focused on a narrow theme of artificial intelligence cuts both ways. If the pace of growth disappoints investor expectations, then we could see a rotation in money flows.
Europe, meanwhile, may have to spend up to $3 trillion over the next decade on defense spending according to a recent Bloomberg article. The aerospace and defense industry in Europe is up 150% over the past three years, beating the Euro Stoxx 600 Index which is up 34%. As European countries lived through tight budgets for most of the time since 2010, it might be time for it to expand.
For investors, this means diversification is finally back. While the other large developed markets may have taken a long nap, global stock markets moving at different speeds can be great for portfolios. It allows us to construct a more robust set of opportunities to participate in economic growth.
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