Not since the 1990s have regional equities diverged to the extent they have today.
That was one, among many, takeaways from a new note penned by Goldman’s Christian Mueller-Glissmann on Thursday.
Headed into 2025, US outperformance reached existential extremes, where that means the ratio of US shares to global shares excluding US equities inflected on a 90-degree angle following the election, turning an already eye-watering chart into something almost farcical.
In the new year, US “equity exceptionalism” slammed into reverse as the mega-caps corrected, investors took a serious look at European shares for the first time in years and gamblers ventured back into Chinese tech.
That means the divergence theme’s still in play in 2025, it’s just going in the opposite direction, with the US for now out of favor and RoW en vogue.
“Regional diversification benefits have been large YTD with non-US equities decoupling from the US,” Mueller-Glissmann wrote, introducing the figure below.
As you can see, the average pairwise correlation between stocks across locales has receded to levels not seen in decades.
Goldman recounted five years of history in explaining the phenomenon. “Coming out of the COVID-19 crisis this reflected less synchronized business cycles due to local COVID waves and different lockdowns, as well as diverging fiscal and monetary policies [while] low regional correlations afterwards mostly reflected strong US equity outperformance,” Mueller-Glissmann said. “However, since the beginning of this year this has started to reverse with US headwinds from tariffs and the Magnificent 7 together with tailwinds German fiscal policy and China tech.”
If you ask the bank’s equity strategists, the reversal theme (i.e., waning US “exceptionalism”) may well “have further to run,” but there’s a caveat. As Mueller-Glissmann put it, “diversification might be challenged if the S&P 500 drawdown deepens.”
Not surprisingly, history shows correlations across regions rise in the event of sharp US equity selloffs as tighter USD financial conditions and faltering sentiment on Wall Street “tend to spill over,” Goldman wrote.
They did the math. When US shares drop 10% or more over a three month period, non-US shares “have rarely delivered positive returns,” to say nothing of instances where Wall Street succumbed to an outright bear market.
This about mag 7, currencies, and fiscal and monetary policy divergence. All of this is unwinding now. Row might not go up if US equities go way down, but it’s likely a bunch of laggards will catch up including foreign stocks even if they are not en fuego. Banks, real estate, small caps might like lower short term rates a lot. And health care may also join the list, since an economic slowdown won’t affect the sector as much. Absent a complete collapse this is healthy.
“While equity market corrections are historically not that uncommon, a coincident Dollar selloff is — especially when equities rapidly reprice. When set against the ten fastest US equity market corrections since 1973, the current one has been unique in its correlation with the Dollar. Intuitively, a rapid correction implies a sudden and unexpected shift in the outlook that can often spill over into broader financial stability concerns—a backdrop that tends to support the Dollar given its global role in markets. Indeed, we find that the Dollar typically strengthened over the initial drawdown of each correction, with the exception of the current episode — the only incidence of a simultaneous selloff in the nominal trade-weighted Dollar.” — Karen Reichgott Fishman and Lexi Kanter, Goldman”
(Perhaps) it IS different this time – while many still cling to the archaic belief that corporate earnings drive stock prices, it has become increasingly obvious that flows from board rooms augmented to a lesser extent by algos and levered speculators along with retail rat packs now determine the short and medium-term trajectory of equity prices. Since 2009 it has been flows not fundamentals that drive share prices.
Through that prism the concurrent weakness in stocks and the dollar are not surprising. Foreign money helped support US stocks and bonds. Now it is getting withdrawn, along with some domestic allocations. So, US stocks are being sold and the dollar proceeds converted and moved into foreign markets. I’d say it is obvious rather than surprising, but what do I know?