Forstrong CIO and president compares U.S. bull run to the Tom Brady dynasty and says COVID-19 has accelerated the end of country's dominance
WP presents a weekly series with Forstrong Global president and CIO Tyler Mordy highlighting and analysing seven macro super trends. In part six, Mordy turns his lens on to ‘the land of the free’ and its juggernaut of a stock market. Don’t miss part 7 next Thursday when we’ll look at investing in the shadow of the COVID-19 financial crisis. If you missed part 1 on the dawn of the fiscal stimulus era, part 2 on globalization in a post-virus world, part 3 on the rise of emerging Asia, part 4 on inflation, or part 5 on splintering world views, click on the links.
Most of us beyond middle age feel a steady creep of declining youth — even the sting of mortality. Then there is Tom Brady.
At 42 years old, the age-defying football player has won more games than any quarterback in history. He led the New England Patriots era of dominance with such consistency that it seemed like a law of physics — a constant winning streak contested by few.
But Brady’s legacy also approached magic. His sustained stretch of outperformance was studded with thirty-six fourth-quarter comebacks, with nine coming in the playoffs when expectation and pressure is at its most intense.
Tyler Mordy, CIO and president of Forstrong Global Asset Management, told WP that investors with U.S.-dominated portfolios over the past decade must have felt like the indominable Brady. Since 2009, the U.S. experienced an almost uninterrupted stock market swing, complete with unstoppable technology titans and a chronically strong currency. Booming corporate profits have underpinned the entire show.
Looking back over that period, the leading stock market in the world has been the United States. Domestic stock prices surged relative to their non-U.S. counterparts by a magnitude that is on par with the 1990s bull run. Most glaringly, European equities have underperformed the U.S. by some 50 percentage points over the past decade.
But, Mordy argued, the problem with long periods of outperformance is investor perception. The association with excellence and achievement builds on itself. With every crowd-pleasing rally or touchdown throw, another coat of varnish goes on.
Soon, an aura of invincibility takes hold. As football fans will know, Brady’s last throw for the Patriots before eventually moving to Tampa Bay was a pick-six – an interception returned for a touchdown – as New England spluttered to an ignominious defeat at the hand of Tennessee Titans. Mordy believes there are parallels, albeit not as dramatic, with the coming underperformance of U.S. equities. Could COVID-19 be the equivalent of Brady’s pick-six? The defining signal that its rule is over and leadership change is upon us?
Forstrong certainly believes so. Old narratives take time to be replaced by new ones but, just like the other super trends in this series, the global pandemic looks set to accelerate this one.
“U.S. equity dominance is at a late stage and looks positioned to roll over from here,” Mordy said. The starting line of its latest dynasty-like run began in 2009, he added, emerging out of the last global financial crisis. The U.S. had a really cheap currency, which is good for exports and nominal growth, and an inexpensive stock market.
“It was also the world-leading monetary polluter as we called them; they introduced game-changing policies to the modern world, including quantitative easing and rapid reductions in interest rates. Through the coronavirus period this has continued. The US policy response has been massive – both in terms of reduced cost of credit and blowing out their fiscal deficit. By contrast, the policy response in most of Asia has been quite muted.”
As well as dropping interest rates dramatically and introducing Q-Eternity, it’s introduced a large buying list of “previously unthinkable” asset classes to its central bank balance sheet, like junk bond ETFs.
Mordy said: “It is fair game to fix the monetary plumbing and address shorter-term liquidity issues. But the enormity of this policy play comes at a huge cost -- borrowing from the future growth and disallowing market signals to work the way they should.
“They’re now talking about big bailouts for energy companies and that type of thing – and we have three decades of hard lessons from Japan for that. After they bailed companies out and underwrote more and more types of risk, zombie companies emerged. Unsurprisingly a long era of slow growth followed. In the U.S., fiscal deficits are going to be blown out completely. It’s going to be a drag on everything, which always leads to slower growth eventually.
“By contrast, you've got other regions of world, most notably Asia, where you’ve seen fairly tame policy responses, meaning they didn't have to do a whole lot to sustain their economies. This bodes well for future growth and gives them policy room when other macro risks emerge.”
The challenge with investment leadership changes is that investors have a hard time updating their mental models when something has worked well for so long. Many come to believe in immutable constants … and magic.
But Forstrong wants to remind investors that bull markets are driven by mortals and ephemeral views, layered with dialectics of suppositions, crowd-driven opinions and, most importantly, flawed assumptions. Unlike in physics, this means what’s right in one regime could be wrong in the next. When Mordy looks back, he believes the American equity domination makes sense.
“In environments of subdued global growth like the one we witnessed in the post-2008 crisis period, U.S. stocks tend to thrive,” he said. “Given that the U.S. has the largest equity culture, home biases tend to enlarge when confidence in the outlook is lacking. The make-up of the U.S. stock market, with its larger weighting in growth stocks, is also a factor. With a sluggish backdrop, growth can command a premium. What’s more, several tailwinds have benefited the US.”
These included the Fed’s role as an aggressive liquidity provider, leading the world in unconventional monetary policy as well as the aforementioned competitive currency and inexpensive stock market. Yet, he argued that few of these factors remain in place today.
“U.S. equity valuations have also become stretched, trading at a 33.6% premium to the remainder of the global benchmark on a price/book basis and some 113% on a forward P/E basis.
“Eight of the world’s top 10 companies by market capitalization are American. And even though the U.S. share of global GDP declined from 32% in 2001 to only 23% recently, its share values nevertheless now commands 63.7% of the MSCI World market capitalization. U.S. stocks are priced for near perfection. Yikes!”
Compounding the market view is deeper fundamental change. America’s waning global leadership has diminished the attractiveness of its country as a destination for foreign capital. Trump’s infidelity to the post-war system and his rants from the Twitter pulpit took a proverbial wrecking ball to long-standing alliances. The country’s response to the COVID-19 pandemic puts it firmly in the laggards category and adds to the perception it is no longer such a safe option.
Mordy added: “’America first’ policies have clearly been counterproductive. Few fans have been made – and in a globalized world defined by a move toward closer interconnectedness, the biggest loser has been the US.
“The political uncertainty in the U.S. is so high, it makes other regions in the world look more stable. If we head back to the starting line, we now have the exact opposite that we had in early 2009: an expensive currency, the world's most expensive developed stock market and waning global leadership.
“So, this super trend is very much intact and, full disclosure, we were early on it. But we really do think this is the one of the big themes for the next decade.”
Just like in sport, no season of outperformance lasts forever. Just as emerging quarterbacks like Patrick Mahomes and Lamar Jackson are taking the torch from Brady, Forstrong’s base case is that select non-U.S. equities will take leadership.
“Expectations for many regions outside of the US are abysmally low, valuations are far cheaper and ex-U.S. growth stories are starting to attract capital,” Mordy said. “Crucially, the U.S. dollar will also begin its foray into a multi-year bear market. Most macro forces that have favoured the dollar — relative growth, interest rate differentials, and a persistent safe-haven appeal — are now reversing.
“Adding all the above, the conditions for a multi-year rotation away from the U.S. have arrived. Longer-running opportunities in Europe, Japan and select emerging markets are now very compelling. Intrepid global asset allocators should prepare for another winning streak.”
Just like Brady’s glittering era at New England, the dynasty of America’s dominance is over.