Capital Economics believes the rapid increase in overseas investment into U.S. equities could become a warning signal for investors, highlighting that similar trends have previously appeared before major stock market downturns.
The research firm said history suggests that periods of exceptionally strong foreign demand have often accompanied rallies that ultimately proved unsustainable.
Equity Holdings Have Overtaken Debt Investments
While foreign investors have long accumulated U.S. assets because of America’s persistent current account deficit, Capital Economics noted that the makeup of those holdings has changed dramatically.
Where overseas portfolios were once dominated by U.S. debt securities, equities now account for the largest share. Foreign ownership of the U.S. stock market has increased from just over 6% in 1997 to more than 21% today.
History Points to Potential Reversals
According to the firm, “substantial increases in foreigners’ net purchases of US equities have coincided with sizeable rallies in the S&P 500 that have subsequently reversed.”
Capital Economics said the current surge in foreign buying is even larger than those recorded before the dotcom crash, the Global Financial Crisis and the 2022 market decline.
AI Enthusiasm Is Driving the Latest Inflows
The firm believes enthusiasm surrounding artificial intelligence has been a major catalyst behind the latest wave of overseas investment.
However, it warned that the trend “is likely to reverse if and when the bubble in AI bursts,” potentially leaving U.S. equities lagging international markets.
Fed Policy Could Shape the Dollar’s Response
Capital Economics added that the impact on the U.S. dollar would depend largely on how aggressively the Federal Reserve responds compared with other major central banks.
The firm said the currency outlook “would probably depend heavily on how much, if at all, the Fed eased monetary policy compared to other central banks.”
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