Last year it would have paid off handsomely to be overweight the US stock market. The S&P 500 index rallied by 23.3% while the global ex-US benchmark gained only 5% (also measured in dollars). The outperformance was led by stronger earnings growth combined with continued expansion of the US price-earnings (PE) multiple. The 12-month forward PE for the US has climbed from 18x to 23x since the current bull market began in September 2023, while the PE for the global ex-US benchmark has barely changed. Investors are willing to pay a steadily increasing amount for every dollar of US company earnings as enthusiasm grows over the country’s tech sector and the AI theme. The year-to date has been different as US stocks have flatlined versus the rest of the world. There has been a marked outperformance by the lagging stock markets. Euro area stocks have strongly outperformed YTD as have UK and Japanese stocks, all from deeply oversold positions relative to the US in hope that the global expansion is broadening out. The same happened last year, but after an initial burst the lagging markets lapsed into continued underperformance, as US earnings superiority reasserted itself.

The big question is, will the US outperform again in 2025, despite its extraordinary premium to other markets. The investment world is torn between those who believe its markets are an accident waiting to happen, that it is only a matter of time before the bubble bursts. Others who believe the “US exceptionalism” story has further to run, assuming a dramatic lift in productivity because of de-regulation and AI technology, which would not only boost profit margins but also help supress inflation. Despite the positive outlook it is understandable that some investors are cautious. The US stock market now comprises around 67% of the global total compared with less than 30% in the late 1980s. We have seen what can happen after a market reaches its peak rating. Japan’s market for instance comprised over 40% of the global total just before its bubble burst in January 1990, it is now around 5-6% of the global total.

Why should the US continue to outperform? A key reason is superior GDP growth. The IMF forecasts the US economy will grow by 2.7% in 2025 in line with its 2.8% growth in 2024, well above other developed economies. The Euro area is expected to grow by 1.0%, the UK by 1.6%, Japan by 1.1%. Another key reason is that the US is benefitting from a widening productivity gap with the rest of the world, which is unlikely to peak soon. Investment in AI, which is accelerating at breakneck speed, provides fertile ground for productivity enhancements. US R&D spend is continuing its structural gain, now comprising 3.5% of GDP compared to 2.5% in the mid-1990s, during the internet-led investment boom. Superior economic growth combined with superior productivity growth should result in continued earnings outperformance. US earnings are projected to increase by 14% in 2025 with the tech sector expected to deliver 22% earnings growth.

At the same time, the macro background is compelling. US household and corporate finances are in rude health. Household net worth has surged in line with a buoyant stock market and property market to above $150 trillion, doubling over the past 10 years. Household debt servicing costs as a percentage of income is at a 40-year low. Cash on corporate balance sheets has quadrupled since the 2008/09 Global Financial Crisis and corporate interest coverage is at a 40-year high. Monetary conditions in the US are easy. Banks are well capitalised and willing to lend while the Federal Reserve is still cutting interest rates. Central banks normally cut interest rates to avert recession but this time round rates are being cut despite solid growth.

Donald Trump’s election in November last year promises an era of deregulation, tax cuts, lower energy costs and the rapid deployment of AI. Notwithstanding the threat of increased tariffs, Trump’s economic policy is like the supply-side stimulus successfully implemented by Thatcher and Reagan in the early 1980s, which paved the way for their economic booms in the 1990s. The US is unique in today’s world in promoting supply-side led reforms. Trump’s policy is also unashamedly pro-US at the expense of the rest of the world, with increased tariffs likely to affect trading partners more than itself. Immigration restrictions would be inflationary and would curb growth but would be more than offset by productivity enhancements.

The US is at the epicentre of the AI revolution and due to its greater capacity to innovate, adopt and adapt to AI, is expected to be its biggest beneficiary in terms of productivity gains, much as it was during the internet boom, the last major technological advance. This reflects more favourable government policy, the dynamism of the private sector, the depth of its capital markets, and the scale of public and private investment in R&D. The number of newly funded AI companies in the US far exceeds that of any other company. Independent macro-economic research firm Capital Economics has developed a proprietary AI Economic Impact Index which ranks major economies according to their potential to realise the benefits of AI, which depends on a variety of factors including economic structure and the approach of policymakers. The US heads the table by a comfortable margin.

All the news and developments are unquestionably positive but how much of it is already in the price? US equity prices have been driven up by fundamentals. Unlike the market’s irrational exuberance of the last 1990s, today’s US stock market PE multiple relative to the rest of the world is being lifted higher in direct proportion to the relative return on capital. Markets have exhibited consistent discipline with very few signs of the excessive speculation which defined the Dotcom bubble. In the case of tech related sectors, valuations today are still only at levels after the Dotcom bubble had finished deflating. The Dotcom bubble and other stock market bubbles indicate US stock prices could go higher. From a valuation perspective there is ample capacity for the US market to outperform again in 2025.

What could be the catalyst for a change in stock market leadership? The most likely would be for relative earnings dominance to shift from the US to other regions. For instance, if the slight pick-up in the global trade and manufacturing cycle picks up proper momentum, although the prospects of rising tariffs are not helpful in this regard. Alternatively, a recession may put an end to US stock market dominance, although in a financial crisis, money tends to flock to safe havens, which tends to be the dollar and dollar based financial assets. US stocks tend to outperform during recessions, given their more defensive nature and returns are bolstered further by the ensuing strength in the dollar. After the Dotcom bubble burst in early 2000, US stock market outperformance continued until 2002.