Advantage U.S.: Its Economy, Stock Market, Interest Rates and the Dollar

The persistently stronger growth of the U.S. economy relative to most other advanced nations has been the driving factor that has resulted in a stronger stock market with higher valuations, higher interest rates and a strong US dollar. A handful of charts highlight the sizable differences in economic and financial market performance across nations. Nothing is permanent, and things—particularly shifts in economic policies--can initiate sizable changes in trends. As we assess shifts in economic policies and central bank monetary policies, it’s important to keep in mind the economic fundamentals that drive financial markets.

Real growth comparisons. Chart 1 shows the cumulative percent change in real GDP since 2000 in the U.S., UK, Europe and Japan. In general, the faster growth in the U.S. reflects a combination of healthier gains in labor force and productivity. Real GDP growth in the UK matched the U.S.’s pace from 2000-2008, while Europe nearly kept pace, benefiting from the boom in global trade fueled by the China super-cycle. While the decade following the Great Financial Crisis was lackluster in the U.S., it was markedly slower elsewhere, particularly in Europe, which was hampered with ongoing financial crises during 2010-2014.

Chart 2 shows the same data but indexes real GDP to 2019Q4, which highlights the U.S.’s continued healthy growth following the pandemic-related contraction in the first half of 2020, while growth in Japan, the UK and Europe has been particularly weak. The persistent outperformance of the U.S. economy is sizable.

The GDP comparison between the U.S. and Canada tells a different story, as shown in Chart 3. Unlike other advanced nations, Canada’s economy kept pace with the U.S. in the early 2000s, benefiting from its strong growth in its labor force fueled by immigration and the high demand for its exports of natural resources. Following the GFC, growth in Canada outpaced the U.S’s soft recovery. Canada’s growth slowed beginning in 2015 with the decline in oil prices and its shift in economic policies that focused on redistribution and social issues and deterred business expansion and economic growth. Canada’s economy has stumbled markedly in the 2020s. To highlight Canada’s weakness and lack of confidence, its business investment as a percent of GDP drifted down prior to the pandemic, plummeted in 2020, and has failed to recover, as shown in Chart 4.

Calculations of productivity vary for different nations and are not directly comparable. However, the U.S.’s pace of technological innovation and the implementation of new innovations into commerce and society seems significantly more pronounced than in other advanced nations. These growth and wealth-enhancing characteristics in the U.S. are facilitated and fueled by the structure of its capital markets, along with its higher degree of risk-taking and entrepreneurial spirit. These characteristics in the U.S. attract global innovators and risk-takers. Various nations are encouraging and rewarding innovation and facilitating advances in capital markets, a distinct positive for global grow. However, at this point, a comparison of pro-growth characteristics in the U.S. and Europe, and Europe’s diminished potential growth, is striking. Note that amid the political turmoil in Europe, its leaders are discussing just about everything except policies that would promote sustainable economic growth.

Labor and employment data are similarly difficult to compare across nations. The U.S.’s labor force has continued to grow and is very flexible, with significantly higher mobility than in other nations. The U.S.’s policies that influence the supply and demand for labor leave much room for improvement, but in general facilitate labor mobility much more than other nations. This enhances the efficiency of business production. The U.S. has also benefited from immigration, and except for Canada, is seemingly more adept than other nations at assimilating immigrants into the workforce and society. Of note, while Japan now welcomes a large and growing number of foreigners into its workforce that offset the impact of its declining population, many nations in Europe, particularly Germany, have policies that constrain the mobility of labor and reduce economic efficiencies.

Stock market comparisons. Charts 5 and 6 show comparisons of the cumulative appreciation of stock markets. Of note, Chart 5 measures the cumulative percent changes in the stock market indexes since 2000 in local currencies, while Chart 6 measures the percent changes in total stock market returns including dividends, in US$ terms. Thus, the recent strength in the US dollar compounds the comparative U.S. advantage.

The outperformance of the U.S. stock market reflects a combination of healthy economic growth, strong profits, growth leaders and high valuations based on favorable expectations. The higher returns on the U.S. stock market generate expectations that the relative advantage will continue. In the last decade, the U.S. has benefited significantly from new growth leaders that garner high multiples. Those stock market leaders have also been the critical drivers of U.S. business investment and growth of the economy. Certainly, there are periods when other nations’ stock markets outperform, but history shows that those periods are temporary. Valuations and P/E multiples are higher in U.S. stock markets that in other markets, reflecting favorable expectations of future economic and profit growth.

Interest rate comparisons. The U.S.’s economic growth and productivity gains raise expected rates of return on capital, which lifts real interest rates. Following the sustained period of low real rates that accompanied the GFC and subsequent decade of weak growth, real rates have normalized. They are now similar to (but still below) the high real interest rates that accompanied the strong productivity-driven growth of the second half of the 1990s. Except for Japan, inflation in all advanced nations has receded, and central banks have raised their policy interest rates above inflation. The Bank of Japan is now normalizing interest rates as it strives to lift inflationary expectations to 2%. Bond yields have risen in all advanced nations and except in Japan, exceed inflationary expectations. Charts 7 and 8 show an international comparison of central bank policy rates and bond yields.

Exchange rates. In an international context, capital tends to flow to the highest risk-adjusted expected rate of return. Accordingly, the higher expected rates of return on US dollar-denominated assets are associated with a stronger US dollar. Charts 9 and 10 show the trade-weighted dollar for advanced foreign economies and the dollar versus the yen and the Euro. The trade-weighted dollar is at high levels similar to levels of the late 1990s and early 2000s before it depreciated significantly and near all-time highs versus the yen.

It is always important to assess how economic policies in the U.S. and globally influence economic and financial market performance. Currently, the potential for shifts in policies is high.