September 25, 2023 | 2 MIN READ

Weekly Market Update

The Value of Seeking Growth in Global Markets

What happened last week?

  • The S&P 500 declined by -2.93%
  • The Dow Jones dropped by -1.89%
  • The Nasdaq plunged -3.62%

This week investors will see data on home sales, consumer confidence and sentiment. But the focus may be on a possible government shutdown at the end of the month due to division among House Republicans and the House and Senate on fiscal priorities.

Since 1995, there have been five shutdowns that have lasted 3–35 days before upsetting voters enough to force a compromise.

We view this as less consequential than the debt ceiling showdown that led to June’s Fiscal Responsibility Act (FRA).

3 Things to Know

US Shares Trade at a Premium over Non-US Shares

US markets look like they are peaking as a share of global market capitalization, measured in US dollars.

The results are a combination of compelling market dynamics. The US dollar has gained 31% relative to a basket of foreign currencies since the beginning of the last decade.

Valuations for the S&P 500 have expanded from 16.3 to 20.0 based on trailing price/earnings multiples. Dividend levels and growth in the US are significantly higher, too. Most importantly, the US has outperformed because its constituent companies have delivered more consistent earnings growth.

Cheaper equity valuations abroad suggest lower expectations for non-US shares. This points to potentially higher future returns abroad than for the US, assuming a change in sentiment.

After the Fed reaches peak rates and declines are more imminent, we believe non-US markets may recover. One factor may be appreciating exchange rates against the USD at that point.

But the larger driver will be earnings and earnings growth. That’s because highly innovative companies providing the best goods and services may generate rewards for shareholders, regardless of their home country.

We made a screen of firms that were profitable in 2022 and have expectations for 20% or more EPS growth in both 2023 and 2024.

It turns out, there are just 76 large cap companies across the world that meet these criteria. Of those, 35 (or 46%) were US firms. The post global financial crisis (GFC) performance of growth stocks outside the US have trailed behind most indices, even “US value.”

Why would this be? The relative performance of the MSCI Growth indices for the US, Europe and Japan provides insight.

Over the past five years, the actual EPS growth rates for the companies underlying the US, Europe and Japan indices are 9%, 2%, and 6%, respectively.

Looking closely, we see that the MSCI European Growth Index has had slower actual profit gains than US Value shares (as defined by the MSCI Value index). It appears that there is a lower bar for being defined a “growth” company in Europe.

In contrast, our own screen of absolute growth companies shows that being a non-US firm does not keep share prices down. Quite simply, non-US markets have slower EPS growth rates and have not been awarded comparable valuations to the US.

Cheaper equity valuations abroad suggest lower expectations for non-US shares. This points to potentially higher future returns abroad than for the US, assuming a change in sentiment.

After the Fed reaches peak rates and declines are more imminent, we believe non-US markets may recover. One factor may be appreciating exchange rates against the USD at that point. But the larger driver will be earnings and earnings growth.

That’s because highly innovative companies providing the best goods and services may generate rewards for shareholders, regardless of their home country.

US Small and Mid-Caps Appear Undervalued to Large-Caps

Looking more broadly at US growth opportunities, the profitable US small and midcap growth shares of the S&P 400 and S&P 600 have seen 11% EPS growth over the past five years.

This is greater than the 9% growth rate for the more expensive S&P large cap US growth index. And the US large cap growth index overall trades at 27X forward EPS vs 16.5X for SMID growth.

US SMID shares have suffered more during the ongoing Fed tightening cycle. Investors were willing to pay more for the largest and safest corporate balance sheets.

We think they have left profitable high growth companies behind. After upgrading these shares earlier this year, we are presently “neutral” in our allocation to US SMID equities given their cyclicality.

Yet, the profitable growth shares within SMID appear undervalued relative to larger firms.

Citi Global Wealth Investments
Charlie Reinhard - Head of North America Investment Strategy
Lorainne Schmitt - North America Investment Strategy

See our weekly CIO Strategy Bulletin for more details