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Will America’s Outperformance Continue?

Global Financial Data has generated indices on the United States and the World Index excluding the United States since 1792. This enables us to compare the performance of stocks in the United States with the rest of the world over the past 225 years. Generally speaking, US stocks underperformed the rest of the world in the first half of the 1800s, but strongly outperformed the rest of the world since the Civil War. After a decline in the relative performance between 1967 and 1988, American stocks have generally outperformed the rest of the world over the past 30 years. Will this trend continue?

US and the World in the 1800s

Figure 1 shows the relative performance of GFD’s US-100 index and GFD’s World x/USA index between 1792 and 2018. Between 1792 and 1864, American stocks underperformed the rest of the world. There were two reasons for this. Until the 1830s, the U.S. stock market included finance stocks almost exclusively. Banks could not operate across state lines and many of the banks could only operate from one location. Thus, the opportunities for growth were limited. If you include the dividends American banks paid, they provided a positive return of 4% per annum before the Civil War, but on average, the price of stocks declined in the United States between 1792 and 1860 by about 1% per annum. In Europe, on the other hand, increases in the share price of canals and railroads supplemented the growth of central banks, providing positive, if modest returns.

Figure 1. United States 100 Index Divided by GFD’s World x/USA Index, 1792 to 2018

 

During the civil war, the United States went off the gold standard and the U.S. Dollar declined in value relative to other currencies. This decline more than offset the inflation that occurred during the Civil War and the net effect was a further decline in U.S. stocks relative to the rest of the world. However, once the Civil War ended, U.S. stocks began a stead rise in value as the American economy industrialized. By the 1890s, Standard Oil was the largest company in the world. The rise in American stocks relative to the rest of the world was modest until 1896, but after that, American stocks began a steady rise in value relative to the rest of the world for the next 70 years.

The United States Outperforms the Rest of the World

The United States suffered from neither the destruction of World War I and World War II nor the economic chaos, inflation and nationalizations that plagued Europe in the first half of the 1900s. Between 1914 and 1929, American stocks rose rapidly in price relative to the rest of the world. U.S. stocks fell back during the Great Depression of the 1930s and hit another low point in 1941, right before Pearl Harbor was attacked, but the next 25 years showed steady growth of U.S. stocks relative to the rest of the world. Almost all of this advance happened in the 1940s as Europe was devastated by World War II. However, even as Europe recovered from the war, American stocks continued to outperform the rest of the world until 1967. Figure 2 compares the performance of the US-100 and the World x/USA index between 1864 and 2018.

Figure 2. USA-100 and World x/USA Price Indices, 1864 to 2018

Table 1 provides a comparison of the returns during different periods of time to stocks in Europe, the World x/USA and to the United States. During the three eras, the United States underperformed the rest of the world only during the Free Trade Era, and most of this occurred before the civil war when finance firms dominated the American market. However, since 1864, American stocks have outperformed the rest of the world and European stocks in every era.

Period Years Europe World x/USA USA
Free Trade 1799-1914 1.58% 1.80% 0.91%
Regulation 1914-1981 1.93% 2.65% 4.38%
Globalization 1981-2018 7.15% 6.27% 8.25%
Post-WWI 1914-2018 3.74% 3.91% 5.73%
Post-Civil War 1864-2018 2.67% 2.79% 4.63%
All 1792-2018 2.44% 2.64% 2.96%

 

Table 1. Price Index Annual Returns to Europe, World x/USA and USA-100

 

If you look at total returns including dividends, you get similar results.

Period Years Europe World x/USA USA
Free Trade 1799-1914 5.30% 5.58% 7.10%
Regulation 1914-1981 6.00% 6.79% 0.98%
Globalization 1981-2018 10.56% 8.95% 11.13%
Post-Civil War 1864-2018 5.98% 5.98% 9.13%
Post-WWI 1914-2018 7.59% 7.55% 2.71%
All 1792-2018 6.28% 6.40% 8.20%

Table 2. Return Index Annual Returns to Europe, World x/USA and USA-100

The peak in the relative outperformance of U.S. to the rest of the world occurred in 1967, but during the next 20 years, between an underperforming stock market and a decline in the value of the Dollar, U.S. stocks fell back to the level they had been at before Pearl Harbor. The decline in the relative performance of U.S. Stocks was also driven by the Japanese bubble of the 1980s. It should be remembered that in 1989, the capitalization of the Japanese stock market was larger than that of the United States. Today, the capitalization of the Japanese stock market is less than 20% of the American stock market.

Figure 3 compares the U.S. market to Europe since 1900. The relative decline in U.S. stocks relative to Europe in the 1980s was not as sharp as the World excluding the United States index. Figures 1 and Figure 3 are very similar up until the 1960s, but the two of them diverge in the 1980s. The U.S./Europe graph declined back to the level it has been at in the 1920s, and reached a lower low in 2008 when the Financial Crisis drove the U.S. stock market down to new lows. Since then, however, U.S. Stocks have risen to new highs relative to Europe.

Figure 3. American stocks relative to European Stocks, 1900 to 2018

Since 1988, the United States has outperformed the rest of the world as globalization, computers, and biotechnology have driven the American market forward. It should have been obvious that the U.S. stock market was undervalued relative to the rest of the world at the bottom of the financial crisis in 2008. Now both graphs are at peaks relative to the past with the U.S./European graph reaching new highs. The question is whether the U.S. market will run out of steam and reverse relative to the rest of the world, or continue its steady increase in value.

American Strength or Foreign Weakness?

Of course, one could argue that it isn’t so much American strength as foreign weakness that has enabled American stocks to forge ahead over the past one hundred and fifty years. While the rest of the world has suffered from wars, defaults, inflation, nationalizations and other impediments to growth in the value of stocks, the United States has suffered from this less than other countries. But will this trend continue? Interest rates have fallen throughout the world revealing little expectation of growth in Europe, Japan or the rest of the world. The United States has outperformed the rest of the world during the past 150 years, and until there are policy changes promoting growth in the rest of the world, there seems little reason to believe that this trend will soon reverse itself.

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