In recent conversations with clients, one question keeps coming up:
“Shouldn’t we just invest in the US stock market?”
At first glance, the numbers make it tempting. US stocks have once again outperformed significantly this year. As of 3rd December 2024, the S&P 500 (the main US equity index) is up around 27.5%, far ahead of indices like the UK’s FTSE 100 (+8.6%) or Europe’s Euro Stoxx 50 (+9.7%).
This performance is driven by a strong US economy and the ‘Magnificent Seven’ tech giants – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – riding a wave of enthusiasm for artificial intelligence (AI).
But is doubling down on US equities, at the expense of global diversification, a good strategy?
We think not.
Please note, when investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up, and you may get back less than you invested, particularly where investing for a short timeframe (we normally recommend a horizon of at least 5 years). Neither simulated nor actual past performance are a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
Think twice about chasing the biggest stocks
When investing, it’s human nature to adopt some degree of extrapolation bias, where we assume that trends observed in the past will continue indefinitely. This can result in overly optimistic or pessimistic predictions about future outcomes, based on limited past data.
However, this strategy has its pitfalls. History tells us that no market, sector or company remains dominant forever.
Reversion to the mean
Overperforming sectors or stocks often revert to average market performance over time, as market dynamics shift.
For instance, in the 1960s, IBM was the dominant force in US equities but eventually lost its position to newer technologies. Similarly, many of the biggest companies from the 1980s and 1990s, such as Cisco, Intel, General Electric and General Motors, have faded from prominence.
Fast forward to the current era, companies like Apple, Nvidia and Microsoft are seen as invincible, yet history tells us that no stock is immune to changing competitive landscapes and new innovations.
This hypothesis is supported by research from Dimensional Fund Advisors.
In the three years before joining the list of the Top 10 largest US companies by market capitalisation, stocks typically outperform the market by an impressive 27.2% annually.
However, in the five years following their rise to the top, they underperform the market by an average of -0.9% annually.
This is shown in the chart below, which spans the period 1927 to end-2023:
2025: a crucial year for AI
The AI frenzy has been a major driver of US outperformance this year. The key question is whether this can continue into 2025 and beyond.
The Economist recently published its ‘The World Ahead’ preview for 2025 and within it, an article ‘Will the bubble burst for AI in 2025, or will it start to deliver?’
The author describes the recent euphoria for AI: “OpenAI’s chatbot attracted 100m users within weeks… spending on AI data centres between 2024 and 2027 is expected to exceed $1.4trn; the market value of Nvidia, the leading maker of AI chips, has increased eight-fold to more than $3trn.”
But the article also cautions: “and yet most companies are still not sure what the technology can or cannot do, or how best to use it… only 5% of American businesses say they are using AI in their products and services… few AI start-ups are turning a profit… the energy and data constraints on AI model-making are becoming steadily more painful.”
While this time may be different, there’s also a reasonable chance it won’t be. Some caution is warranted.
A balanced approach
So, how should we respond?
While US equities make up around 66.6% of the global stock market, the current level of concentration risk is a real concern. Our preferred approach balances exposure to the US (we follow MSCI weightings) with diversification across regions, industries, and asset classes.
We also favour a factor-based strategy, tilting toward smaller, value-oriented stocks, which historically offer strong long-term returns.
Diversification is key to managing risk and capturing opportunities worldwide. It ensures resilience against market volatility, sector downturns, and unforeseen events, providing a smoother and more reliable path to achieving your financial goals.
In summary, while the US market is undeniably compelling, history reminds us that betting on one region or sector is rarely the best approach. Diversification remains the cornerstone of long-term investing success.
Please note, this blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require in order to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
