Persistent outperformance of US equity markets

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One of the features of 2018 has been the outperformance of US equity markets (see exhibit 1 below):

Exhibit 1: US equity markets have outperformed other asset classes in 2018

Source: Bloomberg, BNP Paribas Asset Management, as at 13/09/2018

This outperformance reflects, to a large extent, relative economic performance: the US economy has remained strong, supported by fiscal stimulus and a patient attitude from the Federal Reserve towards monetary tightening. This contrasts with the eurozone and EM where growth, while still robust, has weakened.

Exhibit 2: Economic divergence between the US,  the eurozone and emerging markets

Source: Bloomberg, BNP Paribas Asset Management, as at 13/09/2018

But there is more to this divergence than economic growth. The US equity market rally has been led by one prominent sector: information technology. The US IT sector accounts for close to 25% of the S&P 500 index and close to 30% if we include Amazon which is usually regarded as part of the consumer discretionary sector. Not only is the US IT sector large, so far it has accounted for 20%-50% of US equity returns since 2016. Indeed, of the roughly 10% rally so far this year, the IT sector has accounted for some 5%.

 Exhibit 3: US IT leads: IT sector contributions to US equity returns are high

Source: Bloomberg, as of September 2018

Many commentators now worry that the rally has been driven mainly by an expansion of multiples, making the IT sector expensive in price/earnings (P/E) terms. In our view, quite the opposite is the case.

Earnings in the IT sector have been strong since 2016. If anything, P/Es on a 12-month trailing basis have compressed so far this year, while earnings are up by 15% YoY.

Relative to other sectors, IT is indeed one of the most expensive sectors with a 12-month trailing P/E of 24, but it is not materially higher than that of most other sectors or the index as a whole, which is at 22.

 Exhibit 4: US IT sector performance has been driven by strong earnings, not just multiple expansion

Source: Bloomberg, as of September 2018

The strong earnings reports tell us that the IT sector is benefiting from the cyclical upswing in the US. But the rally is now looking extended, especially so at a time when regulatory risks are rising, both domestically and abroad. We would therefore not be surprised if there is a correction relative to other sectors in the near term. Our dynamic technical analysis suggests that the sector’s outperformance relative to the overall index looks vulnerable.


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Guillermo Felices

Senior Market Strategist, Multi Asset Solutions

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