Allocation to US equities – Part 2

Virtuous cycle between innovation and earnings growth

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Article Type
Insights
Topic
Opinion
Published
July 04, 2025
Read time
5 mins
Authors
Jacob Vijverberg, CFA
Jordy Hermanns, CFA
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The American stock market is typically a large part of investors’ global equity exposure. However, recent developments have raised skepticism and European investors are now reconsidering their allocations to US equities. In this series of short articles we zoom in on positive and negative factors for US equities. We will address topics like innovation, earnings growth, valuation and of course the potential impact of policy changes. 

Earlier, we published the first article in this series where we explained the situation at hand. In this second article, we zoom-in on a positive driver for US equities: innovation driving earnings growth.

 

US R&D supremacy

One of the formidable strengths of US equities has been the high earnings growth. We argue this is due to high spending on research and development (R&D). Through R&D, new products emerge that command dominant market positions. consequently, companies have pricing power that results in higher profit earnings, enabling further R&D investment, hence resulting in a virtuous cycle of growing earnings and more innovation.

 

Chart 1 shows R&D spending by US and European companies. It reveals US spending was about one-third higher from 2015 to 2018. In the period thereafter, this gap widened to over twice the size. As it stands today, the US has clear edge in &D spending, which is likely to lead to new innovations.

 

Spending on R&D (bln USD)



Chart 1: R&D spending. Source: Bloomberg, Aegon Asset Management. Data as per 2024.

 

Charts 2 and 3 offer a more detailed breakdown of global R&D expenditures. In absolute terms, the United States leads the world, investing approximately $800 billion annually in research and development. China follows closely, with annual R&D spending reaching $670 billion—a remarkable increase from less than $50 billion at the start of the 21st century.

 

Japan presents a contrasting trend, with R&D investment remaining relatively stable at around $150 billion per year, resulting in a widening gap compared to other major economies.

 

When viewed in relative terms, the US also ranks high, allocating about 3.5% of its GDP to R&D. Notably, South Korea and Taiwan surpass all other economies in R&D intensity, driven largely by their semiconductor industries. In contrast, Europe invests around 2% of GDP in R&D, with countries like Spain and Italy far below the European average.

 

Spending on R&D per region (in bln USD)

Chart 2: R&D spending per region. Source: National Center for Science and Engineering Statistics, National Patterns of R&D Resources. Data as per 2022.

 

Spending on R&D

Chart 3: R&D spending. Source: National Center for Science and Engineering Statistics, National Patterns of R&D Resources. Data as per 2022.

 

Earnings and R&D: Chicken and egg 

Several of the MAG 7 companies have been particularly successful using their innovations to create near monopoly like market positions. Take for instance, the 90 % market share of Alphabet in search, or the 70% market share of Microsoft in laptop operating systems. This has resulted in high margins and growing earnings, in turn driving increased R&D spending to maintain their lead. Also Nvidia serves as a prime example of successful R&D investment in the US, with net margins exceeding 50% and earnings growing from just 6bln in 2023 to 77bln in 2024. 

 

Corporate earnings (bln USD)

Figure 4: Corporate earnings. Source: Bloomberg, Aegon Asset Management. Data as per 2024

 

As the title of this article suggests, there is a virtuous cycle between R&D and earnings. Higher earnings enable increased R&D spending, while greater investment in R&D paves the way for higher earnings. Breaking this cycle for European companies is very challenging. It's akin to the chicken-and-egg scenario, with earnings being the chicken and R&D the egg. The US boasts both: companies with high profit margins and rising R&D spending.

 

Private sector importance

Private sector spending in the US on R&D is substantial (see figure 5). Businesses invest approximately $670 billion annually in R&D. In comparison, public sector R&D spending in the U.S. is around $150 billion per year. Meaningful, but much lower. These figures highlight that the public sector would struggle to match the private sector's investment in innovation. Therefore, a profitable and innovative private sector is essential to sustain and increase R&D spending.

 

Spending on R&D by source in the US

Figure 5: Spending on R&D by source in the US. Source: National Center for Science and Engineering Statistics, National Patterns of R&D Resources. Data as per 2022.

 

Several US policies will threaten innovation momentum. Restrictions on immigration and targeting universities will curtail talent influx and academic contributions to R&D. Despite these headwinds, the size of the private sector’s investments in innovation might still sustain the United States' competitive edge.

 

Implications for Europe

For European policymakers, these insights also have implications. European consumers are effectively subsidizing R&D and innovation by US companies by buying technology services. Europe would be wise to support home-grown innovations and foster its own companies. This could lead to a similar virtuous cycle of earnings growth, R&D spending, and growth in general well-being.

 

Conclusion

In this series of short articles we zoom in on positive and negative factors that shape the US equity landscape for European investors. In this short article we elaborate on the strong R&D position US companies have. This is a strategic advantage that supports the long-term return potential of US companies.

 

The robust cycle of R&D and earnings has positioned US companies at the forefront of innovation and profitability. Despite the potential obstruction to innovation posed by current government policies, the robust and sizable private sector in the US is expected to uphold its competitive advantage through substantial R&D investment.

 

What’s next

In the next article in this Allocation to US equities series, we deep-dive in the topic of equity valuations.

Important information

Authors

Jacob Vijverberg, CFA
Head of Asset Allocation
Jacob Vijverberg, CFA, is head of asset allocation. He is responsible for both strategic and tactical asset allocation. The team is managing a wide range of multi-asset funds  
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Jordy Hermanns, CFA
Portfolio Manager
Jordy Hermanns, CFA, is a portfolio manager in the multi-asset group and serves as an investment strategist in the asset allocation team.
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