The Hidden $7.7 Trillion Catalyst That's Fueling U.S. Stocks

While Wall Street tends to focus almost exclusively on the attitudes and trading patterns of U.S.-based investors, a surge of buying from overseas has been an overlooked source of strength for U.S. stock prices. Holdings of U.S. equities by foreign private investors reached a record high of $7.7 trillion in July, more than double the amount in 2012, according to the most recent data compiled by the U.S. Treasury Department, as cited by The Wall Street Journal in a detailed report summarized below.

“What’s happened in the last 10 years is that high returns have also been associated with the safety that comes with the U.S.,” observes Paul Sandhu, head of multi-asset quant solutions for Asia-Pacific at BNP Paribas Asset Management. “Usually when you think of safety, you equate that with low returns. But that hasn’t been the case,” he added. Specifically, the S&P 500 Index has outperformed non-U.S. stocks in 9 of the past 10 years, including 2019.

Significance for Investors

“You’re seeing a real divergence between growth prospects in the U.S. equity market and the rest of the world,” according to Hannah Anderson, a global market strategist at JPMorgan Asset Management in Hong Kong. Right now, despite high valuations, U.S. stocks remain attractive to foreign investors based on better projected GDP growth than other developed economies, a strong labor market, and robust consumer spending.

The consensus among analysts calls for 9.7% growth in EPS for the S&P 500 in 2020, per data from FactSet Research Systems. The comparable figures for major overseas indices are 8.6% for the STOXX 600 in Europe and just 2.6% for the Nikkei 225 in Japan.

After the 2008 financial crisis, the U.S. economy and banking system staged a much faster rebound than Europe. Indeed, since the crisis, U.S. banks have become increasingly dominant internationally, while their smaller and less profitable European rivals have become less competitive and forced to retreat from the U.S. market, per another report in the Journal. Meanwhile, Japan has been mired in decades of economic stagnation, with no end in sight.

Additionally, the U.S. has led the technology boom that is changing the world economic landscape, including financial markets. Moreover, U.S.-based giant tech companies, such those in the so-called FAAMG group, are both the tech leaders worldwide and among the largest and most influential corporations within the U.S. itself.

As a result of all this, foreign private investors should continue to be net buyers of U.S. equities, giving the U.S. market added upward impetus. Moreover, the $7.7 trillion figure cited above does not include the holdings of sovereign wealth funds and central banks. As a result, total international holdings of U.S. stocks, and potential future purchases thereof, are probably significantly greater.

Real estate is an example of a countervailing trend, as foreign investors were net sellers of U.S. commercial properties in Q2 2019, per another Journal article. This was the first quarter since 2013 in which they were net sellers. However, in reducing their net exposure to U.S. commercial real estate by $0.8 billion in the quarter, these investors appear to have been freeing up funds for redeployment into U.S. stocks and bonds, where foreign buying has been brisk.

Looking Ahead

Another source of demand for U.S. stocks comes from U.S.-based investors who are shunning international equities, concerned about geopolitical tensions and slower growth abroad. “People just don’t want as much foreign stocks than they used to,” as financial advisor Scott Hanson told CNBC. “I think a lot of people are questioning what’s the point of taking that risk,” he added.

A potential longer-term negative for the U.S. economy is declining foreign direct investment. After reaching a high of $440 billion in 2015, it fell sharply in 2016 and 2017, before recovering partially to $296 billion in 2018, 38% below the 2015 peak, per CNN. Not surprisingly, the biggest drop has been in investment from China.