Why US Stocks Could Continue To Trail International Equities

Forbes

01-05-2025

Background stock market and finance economic.
getty
A commonly heard quip of economists throughout the post-war era has been, 'When America sneezes, the rest of the world catches cold.' This refrain also applied to the 2008 Financial Crisis and the Covid-19 pandemic, when the U.S. economy and stock market far outperformed its international peers (see chart below). This adage, however, does not apply to the current trade war.
During the first 16 weeks of this year, the U.S. stock market underperformed international markets by the widest margin since 1993, according to the Financial Times. The MSCI USA index lost 11 percent, while the MSCI international index rose 4 percent in dollar terms. An 8 percent weakening of the dollar against a basket of six key currencies including the euro and yen was a contributing factor.
US versus International Equities
MSCI
Bloomberg
The U.S. stock market's underperformance is widely attributed to investors' expectations that President Trump's tariff blitz will contribute both to a slowing of the U.S. economy and to higher U.S. prices. This reflects a sea-change in expectations from the start of this year, when investors anticipated that the U.S. economy would be bolstered by tax cuts and deregulation.
The shift in expectations is apparent in the IMF World Economic Outlook published last month. The IMF's projections now call for U.S. real GDP growth to slow from 2.8 percent in 2024 to 1.8 percent this year, down from 2.2 percent in the prior forecast in October.
The IMF's projected slowdown for the U.S. is the largest for any advanced economy, and it is expected to be accompanied by a surge in U.S. inflation to 3 percent, a full percentage-point increase from the January forecast. If so, this outcome would indicate that the massive tariffs President Trump is contemplating would inflict greater damage on the U.S. economy than on other industrial economies.
This begs the issue of whether the U.S. economy might prove resilient to tariff increases, just as it did to Fed rate hikes in 2022-2023.
First quarter GDP results released by the Bureau of Economic Analysis showed how the economy fared just before President Donald Trump's 'Liberation Day' announcement on April 2. During the quarter, real GDP contracted at a 0.3 percent annual rate, which heavily influenced by the response of U.S. businesses to pending tariff hikes..
The main factor contributing to the decline in real GDP was a surge in imports of 41 percent at an annual rate, as businesses built up inventories in anticipation of higher import prices due to tariffs. By comparison, exports rose at only a 1.8 percent rate.
The steep plunge in consumer confidence readings this year was accompanied by a slowing in consumer spending to a 1.8 percent annual rate from 4 percent in the fourth quarter of last year. However, business fixed investment surged at a 22.5 percent rate, as companies appeared to be front-running tariffs according to the Wall Street Journal. Overall, domestic demand rose at a 3 percent annual rate.
The full brunt of the tariff hikes is likely to be felt in the next two-three quarters, as supply-chain shortages take hold. The longer the trade war persists, the greater is the risk that a recession could unfold at some point, which is not yet reflected in stock prices.
Meanwhile, the U.S. stock market has stabilized following President Trump's announcement on April 9 that reciprocal tariffs would be suspended for 90 days for U.S. trading partners. The principal exception is China, where the tariff rate was boosted to 145 percent in response to Chinese retaliation.
Looking ahead, the case for international markets to outperform the U.S. market hinges on three considerations.
One is that international equity markets, and especially European markets, are considerably cheaper than the U.S. stock market even after taking into account the greater weight in technology stocks in the U.S. For example, the average P/E ratio for international stocks over the past decade was more than 20% lower than the U.S. average. By comparison, the current discount for European equities is more than 35 percent according to Bloomberg.
Second, President Trump's stance on national security issues and on tariffs has been a catalyst for European countries to boost defense spending and to undertake other initiatives to bolster their economies. Germany's stock market received a boost when newly elected Chancellor Friedrich Merz won lawmakers' approval in March for an ambitious plan to loosen the nation's strict debt rules for higher defense spending and to set up a large fund to finance public infrastructure. The stock markets for Germany, Poland and Spain, in turn, have posted double-digit returns so far this year.
Third, the backlash to President Trump's tariffs and national security stance has also resulted in a marked decline in the dollar this year, even though interest rate differentials have widened in favor of the dollar. This has raised the specter that there could be crisis of confidence in the dollar at some point, as I have discussed previously. Meanwhile, the status of the U.S. as a safe haven is being questioned.
Finally, in the event the trade war leads to a rupture in global trade patterns, equity market correlations could decline after they rose steadily during the era of globalization. If so, investing in international equities should provide greater diversification benefits than was evident in the past 25 years.