Record funds pouring in, yet resulting in the worst relative performance in 15 years! The halo around U.S. stocks fades, and the dollar alarm sounds?

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U.S. stocks are experiencing an awkward situation of "the more you buy, the worse you perform.” Deutsche Bank warns that if the record influx of foreign capital into U.S. stocks reverses, the dollar will face severe downside risk.

According to Wind Trading Desk, on February 25, Deutsche Bank macro strategist Tim Baker released a report showing that, despite global funds pouring into the U.S. stock market at an unprecedented rate, the relative performance of U.S. stocks has been surprising. “The U.S. market is lagging—better performance is found in cheaper, more cyclical markets.”

In Deutsche Bank’s view, the key is not just the change in stock market ranking, but whether it could trigger a bigger chain reaction: whether overseas investors’ “belief” in overweighting U.S. stocks will be shaken, and whether this shake-up would pull funds away from the inertia of “buying U.S. stocks and holding dollars.”

Funds Flowing Into U.S. Stocks Equal to 2% of GDP

“The degree to which U.S. stocks are favored across the entire market is incredible. Net inflows of equities have never been this strong.” Tim Baker stated bluntly in the report, “Throughout 2025, net inflows reached a staggering level equivalent to 2% of U.S. GDP.”

This is an extremely large figure. Deutsche Bank points out that this record-breaking net equity inflow alone is enough to single-handedly finance two-thirds of the U.S. current account deficit.

During this capital feast, not only are foreign investors frantically buying U.S. stocks, but domestic U.S. investors also exhibit strong “home bias.” The report shows that American investors’ willingness to buy foreign stocks remains weak. In the past year and a half, the U.S. stood out among the G10 nations. Except for the U.K., which barely comes close, most G10 nations have seen net outflows of equity funds.

"Worst Year in 15 Years": Buying the Most but Underperforming Globally

However, the frenzy for capital has not yielded equivalent returns. In hindsight, this mad rush to buy U.S. stocks appears extremely ill-timed.

For over a decade, buying U.S. stocks on the dips was a no-fail strategy in global markets. But the rules of the game changed dramatically in the past year. Deutsche Bank observed that the strongest performers are no longer U.S. stocks, but those markets that are cheaper and more cyclical.

Awkwardly, U.S. stocks are neither cheap nor cyclical.

“The degree to which U.S. stocks are underperforming non-U.S. assets has already appeared in recent year-on-year calculations. Such relative underperformance hasn't been seen in the past 15 years,” Tim Baker noted. Although over a three-year period, U.S. stocks remain robust, they are now at their recent lowest point.

Why are cheap and cyclical markets outperforming? The logic lies in strong global macroeconomic conditions.

The momentum of global economic data exceeding expectations has persisted for more than a year, marking the second-longest streak of positive records. Positive economic data are highly correlated with global stock market gains. In particular, the environment is extremely favorable for corporations.

“Global corporate earnings are growing at over 15%. This isn’t unprecedented, but typically only happens during post-recession recovery periods (such as 2010 or 2021) or at special macroeconomic turning points (like U.S. tax cuts in 2017 or the emerging market boom in the 2000s).”

Non-U.S. Assets Are Having Their Moment

Facing the worst relative performance in 15 years, combined with initially over-allocated U.S. stock positions, long-term investors have ample reason to reconsider the direction of their funds.

For capital to be moved, a core premise must be met: non-U.S. markets (Rest of the World, RoW) need to be able to keep up with U.S. stocks. Deutsche Bank believes this premise now not only holds, but is highly reasonable.

First, there’s the motivation of a valuation recovery. Over the past year, the valuation gap between U.S. stocks and non-U.S. markets has narrowed somewhat, but remains huge. Deutsche Bank data show the U.S. stock price-earnings (PE) premium once reached 70%, and although it has retreated, it remains at an absolute high of 40%.

More importantly, the catalyst is a reversal in earnings fundamentals—a turning point full of imagination.

“The earnings story for non-U.S. markets is finally beginning to turn in a favorable direction. For 15 years, non-U.S. asset earnings were almost stagnant, while U.S. stock earnings nearly tripled in the same period,” Tim Baker emphasized in the report. “But now, non-U.S. market earnings have shown a significant upward trend—they’ve surged by 14% in the past six months.”

Of course, Deutsche Bank remains objectively restrained. The report points out that the convergence of valuation and earnings has a ceiling. U.S. companies’ earnings ability still far exceeds those of other regions. The net asset return rate (ROE) for U.S. stocks is in the teens, while for non-U.S. markets it is only in the low teens.

This structural profitability gap means valuations cannot fully converge. But Deutsche Bank believes that a reduction of the U.S. stock valuation premium to the reasonable range of 20%-30% is entirely possible.

Additionally, the market needs to be wary of a potential risk: the record capital expenditure (Capex) by U.S. businesses. If this ultimately fails to yield high returns, it will directly drag down their future profitability indicators.

Core Play-Out: How Does Capital Outflow Sound the Dollar Alarm?

If funds leave due to diminished cost-effectiveness of U.S. stocks, the forex market will face an inevitable shock. This is the macro transmission logic investors need to pay attention to now.

Deutsche Bank clearly points out that underperformance of U.S. stocks leads to a decline in capital inflows, thus dragging the dollar lower—a pattern with clear historical precedent.

Turning back the clock to the late 1990s. Following the tech stock boom and bust, from 2002 U.S. stocks began to significantly underperform globally. Net inflows quickly turned negative, and the dollar entered a multi-year depreciation cycle.

“While the drop this time may not repeat the severity of that period—since it was accompanied by an epic boom in China and emerging markets—the direction of capital flows then is highly instructive for today,” Tim Baker warns.

From a longer perspective, the logic of forex market pricing is very clear: the long-term trend of the dollar closely tracks U.S. stock market performance relative to emerging markets (EM).

Though both are causal, it perfectly matches the current macro play-out: facing high valuations and underperformance, if record foreign capital stops buying or even exits U.S. stocks to seek more cost-effective assets in emerging markets or other non-U.S. regions, the dollar, losing the annual GDP 2% capital support, will face a full-scale downside alarm.

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