The U.S. market this decade has solidified its global dominance, primarily through a few large technology companies, such as Apple, Microsoft, and Nvidia. The Magnificent Seven, now with Broadcom replacing Tesla, redefined what innovation and returns meant. But in 2025, investors may be reconsidering their relationship with U.S. equities, as international markets, especially in Europe, now show some promise.
Non-U.S. stocks, by some accounts, have so far witnessed gains of about 14% in the current year, whereas those of the S&P 500 have managed only a 2% rise reported by James Mackintosh on Wall Street Journal. Half of these international returns would lie in a weakening U.S. dollar, whereas this, along with some other factors, perhaps signals a much deeper questioning of where value and opportunities reside.
Emerging technology has very much established the recent success of the United States. According to UBS HOLT research, R&D expenditure of the seven largest U.S. corporations has surpassed that of all publicly listed European companies combined. This offensive investment has created barriers to entry and profits with the advantage of incumbency. R&D expenses are an excellent signal of earnings in the future, and from 2007 to 2023, the U.S. has tripled its R&D gap over Europe.
That doesn’t in any way suggest that Europe has always been in the state of being a laggard. Between 1995 and 2010, European stocks outperformed their U.S. counterparts, returning 220% as compared to 130% by the S&P 500. The scenario changed only post-2010 eurozone debt crisis and the tech boom in the United States.
The thing that hurt Europe went beyond missing out on the tech boom; it was stagnation in policies. Rigid labor laws and heavy regulation, coupled with austerity in post-crisis times, prevented the flexibility and productivity of companies. Hence, European companies have underutilized their resources and earn lower ROI than their U.S. counterparts. Besides, big U.S. companies enjoy profit margins that are not only far above those of large European companies but also significantly higher than those of smaller companies across both continents, which perform at about the same efficiency.
However, there is an argument to be made that Europe may be turning a corner. For the first time in years, significant fiscal stimulus is on the cards by European governments, with a focus on defense and infrastructure investment as key tools for growth rejuvenation. On the other hand, the European Central Bank has started cutting interest rates, thereby providing some monetary support even in view of the inflationary risk stemming from a geopolitical tension triggered by Israel's recent strikes on Iran.
The valuation question has been raised. U.S. stocks, more so the giants, are priced much, much higher. According to data from LSEG, the forward price earnings ratio from the U.S. market remains highly elevated compared to that of Europe. For an investor, this means that while American companies may perhaps be more innovative, they cease to be cheap. On the other hand, European stocks seem to be getting some interest from persons who wish to diversify away from tech-heavy U.S. portfolios.
According to Jim Caron of Morgan Stanley Investment Management, "There is a rotation going on." With Europe getting a fiscal and monetary tailwind, plus the lower valuations and improving sentiment, global investing suddenly isn't really scary; It's quite strategic.
TLDR: While the U.S. still leads in innovation, investors are beginning to ask whether the next big thing is overseas.
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