Superstars for too long: Time to move away from India, US equity markets?

Investors face a crucial decision. While the US equity market may face short-term underperformance, the jury is still out on India's potential

The dilemma most investors currently face is what to do with the US and India. These two have been the best-performing equity markets in the world over the last 30 years, but they are currently the two most expensive. Should one believe in regression to the mean, and move away from these two equity markets in the belief that valuations always return to the mean? They have outperformed for too long — is it time for other markets to shine? Or should one continue with the momentum? The US and India have delivered the best returns in dollar terms over the last 30 years, and they have done so consistently. Why change what is not broken? What could cause these markets to now underperform, beyond valuations? Valuations, as is well known, are not a timing tool and there seems to be nothing on the horizon to improve the relative prospects of other markets.

This decision to either let your bets ride on the assumption that current momentum will continue, or to switch your assets into relative underperformers is the biggest call any global investor needs to make.

When one looks at the US, its long-term track record is phenomenal. It has not paid to bet against the US. At the beginning of the 20th century, the US accounted for about 15 per cent of world market capitalisation, second only to the UK, which was at 24 per cent. By 1910, the US had crossed the UK to become the largest equity market in the world. It has since retained this title, unchallenged except for a brief period in the late 1980s when Japan held the top position. Japan peaked in 1989 at 40 per cent of world market capitalisation, while the US was second at 29 per cent (all data for this article has been taken from the UBS Global Investment Returns Yearbook). Today, the US remains unchallenged, accounting for more than 62 per cent of world market capitalisation. The next largest market is Japan at 6 per cent, followed by the UK at 3.7 per cent, and China at 2.8 per cent (all based on the FT World Index and free float adjusted). Just 12 markets, including India, account for 90 per cent of world equity market capitalisation.

Looking at the longest available data series on equity market performance (1900-2023), spanning 124 years, we see that the US has delivered the best real returns, with an annualised rate of 6.5 per cent. The only market even close is Australia at 6.45 per cent in dollar terms, though there is no comparison in terms of size or absolute market capitalisation created. The UK has delivered 4.9 per cent real return, while Germany and France lag with return profiles of only 3.3 per cent  and 3.16 per cent, respectively. Japan delivered 4.2 per cent (all in dollar terms). Compared to the 6.5 per cent real return of the US, the world ex-US, delivered 4.3 per cent, a gap of 2.2 percentage points compounded over 124 years. This leads to huge differences in terminal value. The US has undoubtedly been the right place to invest. If an investor had been exclusively invested in the US for the entire 124 years, their return would have turned one dollar into $2,443 in real terms. The same dollar invested in non-US markets would have grown to only $191, not even one-tenth of the US investment portfolio. It has been a fundamental mistake to avoid or underweight the US. For a buy-and-hold long-term investor, it has absolutely made sense to be structurally overweight in US equities. Like owning a good long-term compounder, it has made sense to simply sit through periods of underperformance or overvaluation.

The ability of the US to dominate new technology and regenerate its corporate ranks is unsurpassed. Its focus on shareholder value creation, belief in free markets, and reward risk-taking is unmatched. The US has the deepest capital markets. No other country has companies like Alphabet, which can spend $50 billion annually on research and development (R&D) and a similar amount on capital expenditures, or a company like Apple, which earns $100 billion in net profit per year. US companies now have market capitalisations and profitability equal to all G7 countries combined. Despite it having a dysfunctional immigration system, the best and brightest still aspire to be based in the US.

While the US markets are clearly not cheap, and may be due for a period of underperformance, can any investor really afford to ignore the country given its long-term track record of relative wealth creation, except for short-term tactical considerations?

For India, the jury is still out. Yes, India has performed incredibly well over the last 30 years, particularly since liberalisation, which marked a significant shift in economic policy. Over this 30-year period (ending July 30, 2024), MSCI India has delivered a nominal annualised return of 8.65 per cent in dollar terms, compared to 5.3 per cent for MSCI. We have a strong entrepreneurial culture, vibrant equity markets, a focus on capital discipline, and dedicated domestic flows. India has done pioneering work on digital public infrastructure, ramped up capital spending on infrastructure, and is well-positioned to benefit from geopolitical and supply chain secular trends. As we cross $2,500 in gross domestic product (GDP) per capita, we are entering a sweet spot for economic growth. Our markets have produced numerous stock-specific multibaggers, a rarity among most other emerging markets (EMs).

We are now the second-largest market in the EM universe. Can India become the US of the EM world? Can we establish a long-term track record of continued outperformance and become the quality compounder of the EM universe? The reality is that it’s not as simple as assuming our markets will automatically do well just because we’re projected to be the fastest-growing economy in the world over the coming decade. Take China, for example, it had incredible growth since 1990, of almost 9 per cent for more than 30 years. However, since 1993 (when China re-entered global indices), despite this impressive growth, China’s equity markets have underperformed global indices by 2.3 per cent annually in dollar terms. There is no direct correlation between GDP growth and market performance.

Our markets are expensive, we have significant expectations built into our valuations. To deliver, we need to execute on population scale and resist the temptations of populism and short-term fixes.  We cannot take our equity performance for granted. Unlike the US, we do not have a 124-year track record. Our pre-liberalisation market returns are only average. We could still flatter to deceive. We have to remain laser-focused on improving economy-wide productivity and the ease of business.

India has a chance to become a default long-term overweight for any EM investor, like the US is for global investors. We should not squander this opportunity.  Strong market returns requires coordinated and effective action from the government, corporate India and investors. To sustain market performance, we cannot afford multiple compression. Multiples depend on earnings, return on invested capital, and the stability of both. This demands effective capital allocation, predictable policy, and a strong focus on productivity. These are the areas we must target.

The writer is with Amansa Capital