Lewis Krauskopf and Sujata Raho

LONDON/NEW YORK – The U.S. stock market may be forced to relinquish the number one spot after their most successful three-year period in over two decades.

With the Fed preparing to raise interest rates https://www.reuters.com/business/finance/inflation-fighting-fed-likely-flag-march-interest-rate-hike-2022-01-26 for the first time in almost four years, capital is starting to fan out of rate-sensitive U.S. shares into other parts of the world where markets are cheaper and potentially more resilient.

The market’s nearly 10% decline so far in this year surpasses losses on all non-U.S. indices. Many believe recent investment outflows from markets, which occurred first in one month according BofA, may be just the beginning.

This view seems to be supported by Goldman Sachs’ (NYSE:) analysis of the eight Federal Reserve hike cycles from 1975.

Over six months, the bank discovered that European stocks performed better than their American counterparts by an average of four percentage points.

This also revealed a shift towards so-called “value sectors” such as banking and commodities, which are well represented in European or emerging market equity benchmarks.

Mike Kelly, PineBridge Investments’ global multiasset leader said “What it really means is to get the hell out of the United States.” It’s about selling assets of longer duration, which means we are less exposed to the U.S. equities.”

In a nutshell: Longer-duration stocks are ones whose price is driven by future earnings potential. They do well in low interest rates.

U.S. tech companies with their exorbitant valuations as measured by their price-earnings ratios (PE) are a prime example and they account for over a third of the S&P 500.

For many years these stocks were a magnet for investment, owing to their low interest rates and the recent pandemic-time shift towards working from home, as well as shopping and dining.

U.S. dedicated funds received a third out of $1 trillion in stocks flows last year. The U.S.-dedicated funds would also have received the largest share of global mandate fund’s nearly $500 billion absorbtion, according to Deutsche Bank (DE:).

Kelly now says that the markets are in an inflection stage, far from where “PE went up and interest rates went down”.

Given that five megacap firms accounted for a third of the S&P 500 performance last year, unloved U.S. sectors should also benefit from rotation.

Martin Schulz is a senior portfolio manager for Federated Hermes (NYSE :). He said he was already overweight in international developed markets last fall, betting on a wide-ranging global economic recovery. We believe that the Japanese and European markets will be big beneficiaries from this globalized recovery.

CHEAP EUROPE

According to BofA, $6 billion was lost in U.S. equity markets during the week ending Jan. 19. Europe and emerging market funds took $2.7 billion and $5.2 million respectively.

Morgan Stanley Graham (NYSE.:) strategist Secker (NYSE.:) Secker also quoted internal data showing that $5 billion was withdrawn from U.S. Exchange Traded Equity Funds (ETFs), while funds focusing on domestic equities lost $8.5 million. European stock ETFs enjoyed $3.6 billion.

Secker said, “We are sensing it qualitatively by investors around the planet to shift a little weight from America to elsewhere.”

Monday’s rout https://www.nasdaq.com/articles/analysis-volatile-markets-fed-uncertainty-add-to-u.s.-dip-buyers-risks rippled out globally, as European shares plunged 4% for their worst day since mid-2020 and emerging equities shed 2%. They may still be better equipped to deal with tighter policies.

Europe trades at 27% less than Wall Street, as opposed to the average 15% discount seen before each of the three Fed cycles. Additionally, value shares in general are 50 percent cheaper than their growth counterparts. This discount is twice that of the rate rises before.

Secker also noted that Europe delivers positive economic data and revisions of earnings higher than the United States.

Citi surprise indexes https://fingfx.thomsonreuters.com/gfx/mkt/akvezedrkpr/Pasted%20image%201643142454609.png

Europe vs US earnings revisions https://fingfx.thomsonreuters.com/gfx/mkt/movanwxqopa/Europe%20vs%20US%20earnings%20revisions.PNG

EMERGING MATERIALS, TOO

All markets will feel it when central banks slow the flow of cash, and depending on what the Fed does, the net supply of cash https://www.reuters.com/business/central-banks-start-turning-off-cash-taps-2022-01-13 from the four big central banks may even shrink for the first time in years.

But this cycle differs in one respect from its last one; China https://www.reuters.com/article/china-economy-rates/china-caps-weekly-policy-easing-blitz-with-fresh-rate-cuts-idUSKBN2JV06J, which hiked rates in 2018 alongside the United States, is now easing policy to support its economy.

JPMorgan (NYSE 🙂 said that a less restrictive Chinese policy will be a benefit to other emerging economies as well as export-focused Europe through trade and commodity prices. It could also mean a 10% uptake for Asian shares in 2022.

Kevin Mahn, chief investment officer at Hennion & Walsh Asset Management in New Jersey, remains bullish U.S. stocks but reckons other markets may soon start to shine as well.

He said, “Perhaps they’ll start to see some of the same growth we saw in U.S. market over the past three years,”