2020 has started with a rise in fear in global equity markets due to the spreading coronavirus. However, over the last year, large-cap U.S. stocks have continued to be some of the best investments in the world. The Nasdaq was up 10% year-to-date to recent highs, while the S&P 500 was up more than +5%. Both indices have pulled back sharply over the past few days but are still among global market leaders for the year. Investors may be skeptical if this leadership can continue, but if you take a close look at the data, there are good reasons why U.S. large- and mega-cap stocks have outperformed.
Numbers don’t lie
We assembled below the median sales and earnings growth as well as certain fundamental and proprietary William O’Neil + Company data of the 20 largest market-cap stocks in 23 developed markets and 24 emerging markets. The top 20 stocks in the U.S., by far the largest market (~54% of developed market cap and ~40% of global market cap), have the highest five-year earnings growth of any market in the developed world. Among developed markets, the 20 largest market cap stocks in the U.S. have the second highest five-year sales growth, the second best pretax margins, and are tied for highest ROE and fastest projected earnings growth next year. When measured against emerging markets, they are tied for second in pretax margins and remain first in ROE. It’s no wonder they are preferred investments for global investors seeking both growth and safety.
20 Largest Market-Cap Companies by Country: Median Growth and O’Neil Metrics
On top of the better growth in the U.S., persistent U.S. dollar strength has given equities a further edge on a currency-adjusted basis and, notably, takes a meaningful bite out of the gains of countries that come closest to competing in terms of growth (India, Turkey, France, Russia). The chart below shows the U.S.’s huge outperformance versus U.S.-dollar-denominated ETFs over the past five years.
Small caps need economic boost to lead
When comparing large-cap U.S. stocks, as represented by the S&P 500, to small-cap stocks, as represented by the S&P 600, the story remains similar. Large U.S. stocks have higher five-year earnings growth than small caps and much higher pretax margins and ROE. Their dividend yield and sales growth are equal to that of small caps. While small caps are forecast to have better earnings growth in 2020, 11% versus 9% for large caps, we are skeptical that this will bear out given the current economic environment. We think it’s more likely that large caps will continue to outgrow small caps as analysts adjust their estimates down after earnings season.
Given small caps’ lower liquidity, profit margins, returns, and stability, the market will need a solid reason for a longer rotation out of current large-cap winners. We think a relative acceleration in small-cap earnings is needed to convince investors that a reversion into small-cap leadership can persist for longer than a few months at a time. We respect the historically wide valuation spread, but we think a reversion is only likely to happen if there is a pickup in economic growth. So far, that remains elusive.
As U.S. 10-year interest rates have fallen, U.S. large-cap stocks have benefited more than mid- and small-cap stocks, as shown on the chart below. We believe that investors rotating out of fixed income are seeking as much stability and safety as possible when buying U.S. equities, which has led them to large-cap stocks that tend to have more liquidity and stability as well as recent higher growth. We believe U.S. interest rates and inflation will remain low in 2020, and that the climate will continue to favor the S&P 500 relative to other U.S. indexes.
DISCLOSURE:
No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. William O’Neil + Company, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.
