SustainAbility: Is this the end of US exceptionalism?

The last few weeks have seen a significant dislocation in equity markets from the trends of recent years.

This rotation can be thought of as the belief that US exceptionalism and US growth are weakening, at the same time as Europe is awakening from its slumber and China is emerging from a property bust. Most investors are not positioned for a world where Europe and China lead equity returns and were this to continue, will need to make significant adjustments. We have begun to see this with European equities seeing their biggest weekly inflow in 10 years. ‘Will this trend continue?’ is the question every investor is trying to answer. No one knows for sure of course but here are some observations which may inform.

Investment 101

One of the most important rules of investing is that it doesn’t matter what you think, only what you think relative to everyone else. If it is in the newspaper, it is usually in the price. If it is a narrative, then it is possible it is already too late. The end of US exceptionalism, and the potential for a recession are the dominant narratives of the media and investors more generally, so there has already been a significant shift in views. This can be seen from the US equity market being down more than 10% year to date, and the German equity market being up 15%. A 25% difference in performance in 10 weeks is noteworthy and already reflects increased pessimism to the US and optimism to Europe.

Another important rule of investing is not to invest in the present. The real skill is to think 12-18 months ahead and try to understand what the world will look like then. The here and now is usually already reflected in prices, the future often is not. The most valuable pieces of information an investor could have today would be if the US is in recession this time next year; if Europe has mobilised promised fiscal spending; and if China has continued its economic recovery. No US recession, European fiscal stimulus, and Chinese economic growth recovering would make investors bullish about future growth and equity market returns, and in turn would make prices after the recent pull back look attractive. Of course, if the opposite sensation plays out, some markets will continue to struggle. Either way, it is not the present which counts in decision making, it is a view on the future.

It is not the present which counts in decision making, it is a view on the future

Alongside avoiding short-term, consensual thinking, what else can help investors at times like these? Understanding that in the short term, macroeconomic, issues are more important to markets, but that in the long-term micro, company and industry trends are more important, helps too. It is important to understand that very few CEOs we meet adjust their strategies to adapt to short-term news and events – most concentrate on how they can improve their companies and grow. This is good lesson for portfolio managers too. Areas such as the growth in the digital economy, investment in physical infrastructure, and increasing innovation in healthcare will happen regardless of the events in markets over the last few weeks. In the end they are likely to be more important than politics and economic data. Listening to and understanding the economic and geopolitical environment we live in is important, but rarely defining over the long term for investment outcomes compared to other more company and industry led factors.

Recession watch

To use the saying, if I had a pound for every time I was told there is a recession looming, I’d be a wealthy man. Despite the US economy being in recession only 15% of the time since 1935, investors consistently worry about the possibility of if happening. Recessions do not appear out of nowhere either. They are usually a result of oil price shocks, financial crises, policy errors, and other events which dislocate the natural rhythm of growth we see for the other 85% of the time.

Concerns about a US recession today are based on the uncertain political environment which its new government has created. Anyone employed by the government will be concerned about their future jobs. This will impact consumer spending. For any company looking to invest, they will be concerned about tariffs causing them to pause. The case for an air pocket in economic growth is a plausible one. That these wounds are somewhat self-inflicted makes them frustrating and solvable, but there is a direction to US economic nationalism, at the expense of globalisation, which looks entrenched.

There are counter arguments to a recession, however. The US banking system is in good health, consumers are still benefiting from wealth effects of equity and home prices over the last few years, while lower taxes and deregulation are part of the Trump economic plan and will benefit the corporate world.

It is difficult to forecast recessions, and no one can say what will happen next. There is however a negative bias towards US economic growth (this is what everyone else thinks, to use the framework introduced earlier) so no recession would be positive for markets as many investors expect one. In my view, an actual recession is already partly priced in.

The end of US exceptionalism?

The idea of US exceptionalism has been that only this country can innovate, regulate, and govern in way which maximises the growth potential of an economy. Europe has been viewed as too bogged down in excessive regulation, political arguments, and taxation to incentivise the behaviours which create economic value. China has equally been looked down on as a single-party country with poor governance and decision-making structures. 

Deepseek, the Chinese company which produced an advanced AI model with much lower power and computation requirements than its US peers, challenged this assumption. This was quickly followed with Europe promising to tear up its fiscal rulebook to spend on rearmament and infrastructure investment. That China can innovate, and Europe can stimulate, were direct challenges to the argument of US exceptionalism. As European and Chinese equities trade at a big valuation discount to the US, it is easy to see why markets have rotated into them.

The consensus view today is the US is waning, Europe is rising and China is re-emerging.

Despite recent events, I think global talent will still want to start a business in the US compared to other countries. The ability to create, be rewarded, and access capital markets which support growth and innovation will remain stronger in the US. This suggests a rebalancing of expectations, not a re-ordering. On that basis, US equity markets should trade at a premium to others, but perhaps not as much as they used to.

Conclusions

The consensus view today is the US is waning, Europe is rising and China is re-emerging. As an investor the questions are what are my views relative to this, and how does this look in the future? A reasonable view would be too much caution is now baked into view on the US economy, but perhaps not enough optimism regarding a real positive change in Europe and China where investment allocations remain low. If true, this suggests that investors are too cautious about all key regions of US, China and Europe over the long term, and that would be a positive thing for future equity returns.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.