Record-breaking capital inflow, but it results in the worst relative performance in 15 years! The halo around U.S. stocks fades, and the dollar warning sounds?

U.S. stocks are facing the awkward situation of “the more you buy, the more you lose,” with Deutsche Bank warning that if the record-breaking foreign capital inflows into U.S. equities reverse, the dollar could face severe downside risks.

According to ZF Trading, on February 25, Deutsche Bank macro strategist Tim Baker released a report showing that despite unprecedented global capital inflows into U.S. stocks, the relative performance of U.S. equities has been surprisingly poor. “The U.S. market is lagging — better performance is seen in cheaper, more cyclical markets.”

In Deutsche Bank’s view, the key is not just the change in stock market rankings, but whether it could trigger a larger chain reaction: Will the “belief” among overseas investors that they are over-allocating to U.S. stocks be shaken? And will this shakeout pull funds out of the inertia of “buying U.S. stocks and allocating to the dollar”?

Funds equal to 2% of GDP pouring into U.S. stocks

“The level of enthusiasm for the U.S. stock market across the entire market is incredible. Net stock inflows have never been so strong,” Tim Baker stated in the report. “Throughout 2025, net inflows reached an astonishing 2% of U.S. GDP.”

This is an extremely large figure. Deutsche Bank pointed out that just this record-breaking net inflow of stocks is enough to finance two-thirds of the U.S. current account deficit on its own.

In this capital feast, not only are foreign investors疯狂买入美股, U.S. domestic investors also show a strong “home bias.” The report indicates that U.S. investors’ willingness to buy foreign stocks is weak. Over the past year and a half, the U.S. has been somewhat out of place among G10 countries. Except for the UK, which is barely close, most G10 countries have experienced net outflows of stock funds.

“Worst year in 15 years”: bought the most, but underperformed globally

However, the frenzy of capital has not translated into equivalent returns. In hindsight, this frantic buying of U.S. stocks appears highly ill-timed.

For more than a decade, buying U.S. stocks on dips has been a guaranteed profit strategy globally. But the game changed dramatically over the past year. Deutsche Bank observed that the strongest performers are no longer U.S. stocks, but cheaper, more cyclical markets.

It’s embarrassing that U.S. stocks are neither cheap nor cyclical.

“The extent to which U.S. stocks have underperformed non-U.S. assets has become evident in recent months on a year-over-year basis. Such a level of relative underperformance has not been seen in the past 15 years,” Tim Baker said. While over a three-year horizon, U.S. performance remains solid, it has now fallen to its recent lows.

Why are cheap and cyclical markets starting to outperform? The logic lies in the strong global macro backdrop.

Global economic data has been exceeding expectations for over a year, marking the second-longest streak of continuous improvement on record. Positive economic data is highly correlated with rising global stock markets. Especially for corporations, the current environment is extremely favorable.

“Global corporate earnings are growing at over 15% annually. This is not unprecedented, but usually occurs during recovery phases after recessions (like 2010, 2021) or at macroeconomic turning points (such as U.S. tax cuts in 2017, emerging market boom in the 2000s).”

Non-U.S. assets enter a counterattack moment

Faced with the worst relative performance in 15 years, coupled with an initial overweight position in U.S. stocks, long-term investors now have ample reasons to reconsider their allocations.

The key premise for capital shifting is that non-U.S. markets (Rest of World) must be capable of at least keeping pace with U.S. stocks. Deutsche Bank sees this premise as not only valid but highly reasonable.

First, the valuation correction driver. Over the past year, the valuation gap between U.S. and non-U.S. markets has narrowed somewhat, but the gap remains huge. Deutsche Bank data shows that the U.S. P/E premium once reached 70%, though it has since retreated, it still remains at a high 40%.

More crucial is a reversal in earnings fundamentals. This could be a highly promising turning point.

The earnings story for non-U.S. markets is finally turning favorable. Over 15 years, earnings for non-U.S. assets have stagnated, while U.S. earnings nearly tripled during the same period. Tim Baker emphasized, “But now, non-U.S. earnings are showing a significant upward trend — up 14% in the past six months.”

Of course, Deutsche Bank remains objectively cautious. The report notes that the convergence of valuation and earnings has its limits. U.S. corporate profitability still far exceeds that of other regions. U.S. stocks’ return on equity (ROE) remains in the teens, while non-U.S. markets are in the low teens.

This structural earnings gap means valuations cannot fully align. However, Deutsche Bank believes that a return of U.S. valuation premiums to a reasonable 20%-30% is entirely possible.

Additionally, markets should be alert to a potential risk: U.S. companies’ record capital expenditures (Capex). If these do not translate into high returns, it could directly drag down their future earnings.

Core reasoning: How could capital outflows trigger a warning for the dollar?

If funds leave due to declining U.S. stock valuations, the forex market will face an inevitable shock. This is the macro transmission logic investors should be paying close attention to now.

Deutsche Bank explicitly states that a decline in U.S. stocks leading to reduced capital inflows, and thus weakening the dollar, has clear historical precedents.

Looking back to the late 1990s. After the tech bubble boom and bust cycle, starting in 2002, U.S. stocks began significantly underperforming globally. This was followed by a sharp reversal of net inflows into U.S. equities, and the dollar entered a multi-year depreciation cycle.

“Although this decline may not be as severe as that of the late 1990s, because that period was also marked by epic booms in China and emerging markets, the direction of capital flows back then provides strong guidance for today,” warned Tim Baker.

On a longer cycle, the pricing logic in the forex market is very clear: the long-term trend of the dollar closely correlates with the performance of U.S. stocks relative to emerging markets (EM).

While causally linked, this perfectly aligns with the current macro narrative: facing high valuations and underperformance, if record-breaking foreign capital stops buying or even exits U.S. stocks and shifts to emerging markets or other non-U.S. regions seeking better value, the dollar’s downward warning will be fully triggered once this 2% of GDP capital support is withdrawn.

This insightful analysis is from ZF Trading.

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