The U.S. economic system and inventory market have outperformed. Can the American exceptionalism final?

However whereas American exceptionalism might or is probably not actual within the political realm, it’s been entrance and middle within the outstanding efficiency of the U.S. economic system and inventory market over the previous few years. And virtually no one noticed this exceptionalism coming.

The US’ post-COVID rebound totally stunned specialists throughout the nation. Seek the advice of the economics textbooks, and the mixed pressure of the worst inflationary wave because the Eighties and quickly rising rates of interest ought to have left the American economic system trying worse for put on. Tack on two international wars which have crimped provide chains and boosted vitality costs, and it is smart why a U.S. recession was the near-unanimous expectation of many economists and Wall Road leaders for years.

Nonetheless, regardless of all these storm clouds, it seems to be like American shoppers and companies have up to now defied the percentages. The economic system continues to grow, with a resilient labor market underpinning its largely surprising success. And whereas critical value of dwelling points stay, the U.S.’s post-COVID rebound has been notably sturdy when in comparison with its developed friends. 

Within the fourth quarter of 2023, U.S. GDP grew at an annual charge of three.3%, in comparison with simply 0.1% for the 20 nations that make up the Euro Space, and 1.1% for Japan. And for all of 2023, U.S. GDP rose 2.5%, greater than some other G7 economic system, based on the Worldwide Financial Fund’s (IMF) World Economic Outlook. 

The financial power has helped U.S. shares trounce their developed market friends because the outbreak of COVID in early 2020. The S&P 500 is up over 53% since Jan. 2020, in comparison with a 16% rise for the STOXX Europe 600 index, a 52% soar for Japan’s Nikkei 225 (non-cap weighted), and a 23% drop for China’s CSI 300 index.

There are a couple of key explanation why the U.S. economic system has outperformed within the post-COVID period, from the nation’s relative vitality independence to its aggressive fiscal and financial response to the pandemic. They’re benefits that would assist American shares keep their distinctive run of efficiency over the following few years.

“The U.S. is still in a better position than most other countries right now,” James Solloway, chief market strategist and senior portfolio supervisor at SEI Investments, informed Fortune. “We’re seeing above average growth, which is somewhat surprising, but nonetheless, it’s happening. So we’ve entered 2024 with a bit of momentum.”

That being mentioned, unpredictable dangers, from the end result of home elections to the affect of international wars, may nonetheless rear their head. And after U.S. shares’ large run-up over the previous few years, valuations are excessive. For traders, meaning going all in on one other period of U.S. inventory market dominance is probably not your best option, even when the U.S. economic system is about to outperform its developed friends. On this period of uncertainty, protecting all of your eggs in a single basket might be dangerous.

“I think that at this point, it pays to be diversified,” Solloway mentioned. “The United States has had a great run, mainly owing to the growth nature of the stock markets here, but valuations have become quite stretched relative to other countries.”

Nonetheless, the U.S. might stay the worldwide economic system’s outlier in 2024—in a great way. And understanding why will help traders resolve which solution to go subsequent, and the way lengthy this period of outperformance may go on.

An enormous fiscal response 

When the outbreak of COVID-19 shut down the worldwide economic system in early 2020, the governments of developed nations took very completely different approaches to supporting their home economies. The U.S. federal authorities was by far probably the most aggressive with spending, allotting $4.6 trillion, or roughly 10% of U.S. GDP in 2020 and 2021, by means of six COVID-19 aid legal guidelines.

SEI’s Solloway famous that not solely did the U.S. have the most important fiscal response to the pandemic relative to the dimensions of its economic system, its COVID aid spending was additionally “much more direct, putting money into people’s pockets and supporting businesses directly, as opposed to just providing loan guarantees.”

This forceful fiscal response might have boosted inflation, Solloway mentioned, however it additionally helped many Individuals keep their incomes throughout a interval when spending was naturally decrease. The mix of comparatively steady incomes and decrease spending helped shoppers construct up so-called “excess savings” through the pandemic. By August 2021, Individuals had over $2 trillion in extra financial savings, and people financial savings helped buoy shopper spending and stop a recession.

Resilience to rising rates of interest

On the financial aspect of issues, the U.S. Federal Reserve was additionally very aggressive in reducing rates of interest to near-zero when the pandemic hit. American shoppers and companies had been fast to benefit from the decrease borrowing prices, refinancing mortgages and different loans whereas charges had been traditionally low. That’s helped them get better from the temporary COVID-induced downturn quicker than anticipated, and keep some spending energy whilst rates of interest have risen.

“Households and businesses both had some insulation from the increase in rates… because both refinanced at very low interest rates,” Solloway mentioned. “And therefore they have not immediately felt the impact of higher rates yet, as opposed to a lot of other countries.”

When central banks hike rates of interest, it raises borrowing prices for all companies and shoppers—and that’s true in each nation. However how rapidly and severely larger borrowing prices have an effect on shoppers and companies isn’t the identical—a truth on show over the previous few years with the U.S. Federal Reserve, the Financial institution of England, and the European Central Financial institution all elevating charges.

Take housing. Within the U.S., 79% of all mortgages had mounted charges of 30 or 15 years in 2023, based on Bankrate. Conversely, within the U.Okay., 74% of mortgages presently have rates of interest which are mounted for 2 to 5 years earlier than they should be re-financed, based on data from the U.Okay.’s Monetary Conduct Authority.

In consequence, 55% of U.Okay. mortgages noticed their rate of interest enhance because the finish of 2021, the Guardianreported in December. However within the U.S., practically 90% of householders nonetheless have mortgage charges underneath 6%, whilst common 30-year mortgage charges spiked to eight% final yr earlier than falling to just about 7%, Redfin data exhibits.

For a lot of U.S. householders, it’s solely when “their situation changes, they have a family, they need to move to a bigger house that they start feeling the impact of higher interest rates,” Solloway defined.

Power independence

The U.S.’s relative vitality independence in comparison with its developed nation friends is another excuse it managed to outperform over the previous few years.

U.S. pure gasoline manufacturing has soared up to now 5 years, hitting a record high in 2023. When Russia invaded Ukraine in February 2022, that meant the U.S. economic system was extra insulated from rising pure gasoline costs than lots of its developed friends. European nationwide gasoline costs, that are extremely reliant on Russian gasoline, peaked at over over $70 per million British Thermal Items (BTU) in August 2022, in comparison with a peak of simply $10 per million BTU within the U.S. 

The U.S. vitality trade has additionally developed a dominant place within the liquefied pure gasoline (LNG) market in recent times, with Europe more and more counting on the U.S.’s LNG. Innes McFee, chief international economist at Oxford Economics, defined that Europe’s lack of vitality independence “puts European industry at a structural disadvantage versus U.S. counterparts.”

On high of that, though the U.S. economic system was affected by rising oil costs after the beginning of the Ukraine conflict, President Biden’s launch of 180 million barrels of oil from the strategic petroleum reserve helped blunt the affect. U.S. vitality corporations had been additionally capable of rake in record profits as their manufacturing soared. That helped increase U.S. company earnings and inventory costs, whereas offering high-paying jobs for a lot of Individuals. 

U.S. oil manufacturing hit a record high in 2023 as properly, and the U.S. Power Data Company expects “improved well productivity” will result in two extra document manufacturing years in 2024 and 2025. That ought to assist forestall one other oil value spike that would exacerbate inflation.

Will the U.S. proceed to outperform?

The components described above are only a few of the numerous that specialists supply to clarify the U.S. economies’ post-COVID outperformance. Different economists level to the U.S.’s extra developed capital markets, saying they allow U.S. companies to readily entry money in powerful occasions, and have helped employers hold onto employees. Nonetheless extra say U.S. tech dominance has made the American economic system and inventory market the main beneficiary of the AI increase. And others word that the direct help for American shoppers within the type of stimulus checks led to a wave of new business formation and the upskilling of employees within the U.S. through the COVID period, which has labored to extend productiveness and financial development ever since. All of this doesn’t even contact on the home financial issues that different developed nations are dealing with—notably China, with its ailing housing market.

Bank of America Analysis, whose personal economists predicted a recession solely to be happily surprised by the U.S. economic system’s sturdy efficiency, have one other thought about what might be driving the U.S. inventory market: traders’ “FOMO.” The World Fairness Derivatives Analysis crew, led by Benjamin Bowler, wrote in its 2024 outlook that “fear of missing out” was “winning the war in investors’ minds” over the numerous materials elementary and coverage dangers including to bigger macro uncertainty. 

The “FOMO” time period is a millennial standby, invented in 2004 by a Harvard Enterprise Faculty pupil writing an opinion piece within the college journal. However the sentiment recollects related euphemisms for investor enthusiasm from many years earlier than: “irrational exuberance” was Fed chair Alan Greenspan’s parlance within the Nineteen Nineties, and “animal spirits” was the popular description from legendary economist John Maynard Keynes within the Thirties. An excessive amount of of this type of factor can create bubbles that instantly burst, simply because it did through the dotcom bust, ending off the Greenspan-era irrational exuberance. 

The actual query, nevertheless, stays: can the U.S.’ run of fine type final? A number of the drivers of the present power are additionally potential liabilities. Dependence on tech monopolies and deficit spending may set off a painful correction. Equally, fading extra financial savings and the excessive value of dwelling may dampen shopper confidence, stifling development. However based on Oxford Economics’ McFee, “the outlook for the U.S. is actually still pretty good relative to other peers in developed markets.”

McFee forecasts 2.5% actual earnings development within the U.S. this yr, which ought to assist help shopper spending, in comparison with simply 1% in Europe. He additionally expects fiscal coverage to be “much more supportive” within the U.S. than in Europe, the place the development is towards “consolidation and reining in budget deficits.”

“The supply side of the U.S. economy looks a bit stronger. And you’ve seen really strong productivity growth in the U.S. this year— that’s not really the case elsewhere,” he added. To his level, IMF economists are forecasting 2.1% GDP development for the U.S. economic system in 2024, greater than some other G7 economic system.

All of that being mentioned, McFee warned that the presidential election yr creates one “big question” that will likely be key to figuring out the economic system’s future.

“What will policy look like after the election?” he requested. “We’ve got the Trump tax cuts expiring next year. So there’s a really big opportunity to shape tax policy in the next administration. And I think that will have a big influence on whether or not the U.S. can continue to outperform other developed markets.”

SEI’s Solloway agreed that the election creates a whole lot of “uncertainty” in 2024, however added that the U.S. economic system has one other characteristic that ought to assist it thrive regardless of who’s in workplace. “You know, the U.S. economy and investors adapt, even in harrowing times,” he famous. “We’ve actually seen a very good economy, and we’ve seen a very good stock market, during some very trying times over the last decade-plus.”