Surge in Foreign Buying of US Stocks Signals Potential S&P 500 Reversal, Analyst Warns

A sharp increase in foreign investment into U.S. equities could be a contrarian indicator signaling trouble ahead for the S&P 500, according to a note from Capital Economics. The firm's analysis suggests that similar surges in foreign buying have historically preceded significant market downturns.

A Historical Warning Sign

John Higgins, Chief Economic Adviser at Capital Economics, pointed out that substantial increases in net purchases of U.S. equities by foreign investors have often coincided with major market rallies that subsequently reversed. The firm cited three key historical examples:

• The dot-com bubble burst in the early 2000s
• The 2008 global financial crisis
• The market drawdown in 2022

Capital Economics noted that the current increase in foreign buying, which has accompanied the recent stock market surge, "has been much larger than the increases in foreigners' net purchases of US equities during the rallies of those earlier episodes."

Shifting Ownership and AI Fuel

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The composition of foreign-held U.S. assets has changed significantly over the past two decades. While foreigners have long accumulated U.S. financial assets due to the country's persistent current account deficit—leading to net liabilities over $21 trillion as of Q1—the nature of those holdings has shifted from primarily debt securities to equities.

According to the note, foreigners' ownership share of U.S. equities has climbed to more than 21%, a substantial increase from just over 6% in 1997. Capital Economics suggests the current trend is largely driven by the AI-fueled rally and cautioned that this buying "is likely to reverse if and when the bubble in AI bursts."

Potential Market Impact

If this historical pattern holds and the buying trend reverses, it could lead to U.S. equities underperforming their global peers, Capital Economics warned. The impact on the U.S. dollar is less certain.

The firm stated that the dollar's performance in such a scenario "would probably depend heavily on how much, if at all, the Fed eased monetary policy compared to other central banks."