Can US markets keep outperforming next year?

In a sluggish year for economies and equity markets in the developed world, the United States has led the way. While countries like Canada and the UK have seen their GDP growth rates slow considerably, or even turn negative, the US economy has bucked expectations and maintained strong growth numbers. Where most equity markets have been choppy, US markets have shown strong aggregate performance.

By mid-December, the European STOXX 600 was up over 10% YTD, the TSX was up less than 5%, the British FTSE 100 was up only 0.28%. In the US, the S&P 500 posted 21% YTD growth. While Japan’s Nikkei 225 exceeded that with roughly 28% growth, even that historic year for Japanese stocks pales in comparison to the tech-heavy Nasdaq, which is up over 51% YTD. US equities have been growth drivers for the better part of a decade, but as interest rate hiking cycles come to an end and we enter a new monetary paradigm, can US stocks continue to lead?

Sadiq Adatia believes they can. The Chief Investment Officer at BMO Global Asset Management explains that the same long-term trends and themes that drove US equity outperformance through this past year should continue to hold in 2024. He expects some headwinds and perhaps some shifts in the companies and sectors leading growth — as well as a rebalance between equities and fixed income. Nevertheless, he thinks there are enough drivers in the US equity market that Canadian advisors should be looking south of the border when considering their clients’ stock allocations.

“More than anything else, US markets have been better because they have the key names within their indexes,” Adatia says. “Those names, the ‘magnificent seven’ as everybody calls them, they have done well on three key factors. One is the themes that they are involve in, longer-term themes like AI, innovation, cloud computing…The second is that these are quality companies, even if we are expecting rates to stay higher for longer, these are quality companies with right balance sheets. The third factor is that US consumers are demanding the products that these companies offer.”

US consumers, Adatia says, are largely responsible for continued US economic outperformance despite headwinds and projections of slowing growth or recessions due to interest rate hikes. He does expect that resilience to flag somewhat next year, as the excess savings accrued during the COVID-19 lockdowns are spent. He notes that only the top 20% of American income earners have any of those savings left and we have seen an uptick in credit card debt which points to an eventual consumer slowdown.

Even as US consumption slows, Adatia still sees some drivers at work in US equities. He reiterates that the scale and quality of the magnificent seven (Tesla, Amazon, Alphabet, Microsoft, Nvidia, Apple, and Meta) should see them through a slowdown. He notes, as well, that there should be some catch-up from other companies in US markets. Outside of a select few mega-caps, US market growth hasn’t been as rosy, but many of the headwinds those other names faced this year are giving way. Adatia says we can already see this trend in sectors like financials, which have rebounded slightly and begun to catch up.

Some investors are still concerned about how high valuations have run on some US stocks, especially the names in the magnificent seven. Adatia notes that some of these companies may have run a bit “too far too fast” in the short-term. However, given the expectation of interest rate cuts next year and the potential long-term value still to be created by technologies like AI he still thinks valuations can be seen as attractive with a longer time horizon.

Adatia notes that the bond market now looks more attractive than it has in years, with the potential to lock in high yields and the likelihood of a pop in value following expected interest rate cuts. While he expects a rotation into fixed income, he doesn’t think that rotation will come as much from profit-taking on US equities. Rather, cash, GICs, and HISA ETFs — which will likely have lower yields — should be the source of capital for bonds.

Contrasting his more bullish outlook on US equities, Adatia takes a bearish view on Canadian stocks. The Canadian consumer is in a much worse position than their American counterparts, largely due to interest rate sensitivity. That pressure on the Canadian consumer is likely to drag on the Canadian economy and Canadian stocks as a result. Adatia thinks it’s time for advisors to reconsider the balance of their US and Canadian allocations.

There are still a wide range of unknowns in the US and global economies. Adatia is watching for US consumption data throughout this holiday season. He’ll also be closely watching Federal Reserve statements and policy decisions to see if the predicted dovish pivot will actually manifest. The 2024 election, too may open certain sectors to political headwinds or tailwinds that Adatia will be watching for.

Overall Adatia believes that equity investors will be well-served in US allocations to companies known for steady returns and strong balance sheets.

“I think you still want to own quality companies in the US, I don’t want to say it’s value or its growth, I think it’s quality companies that have the moat,” Adatia says. I also think dividends are going to start coming back as well too because I think in the last few years quality has not been in favour, and I think you’re going to start to see that as people see bond yields go lower the thirst for yield will still be there.”