The term “American exceptionalism” can be traced back to 1840. However, it wasn’t until a century later that the expression started to be more widely used in reference to the dominant position the US found itself in at the end of the Second World War. At this point in history, it had 80 per cent of the world’s gold, accounted for half of the global economic output and had a monopoly on nuclear weapons. These days American exceptionalism refers to the belief that the United States is either distinctive, unique, or exemplary compared to other nations, especially the theory that the peaceful capitalism of the US constitutes an exception to the general economic laws.
Despite almost 25% of our equity holdings being in US assets, one of the most asked questions from advisers, and often clients, is: why don’t we hold a greater allocation to the US?
Yikes
North American equities struggled in 2022, underperforming other developed markets, an important point considering that the US makes up almost 70% of the MSCI World index. Yet there still seems to be a sense that this is just a temporary blip. A quick look at the most recent statistics from the Investment Association bears this out. While Global funds saw net outflows of £157m in January, UK retail investors pumped £364m into the IA North America, making it the most popular sector of the month. In the same month, some £1.3bn was redeemed from the IA UK All Companies sector. We believe that rear-view mirror investing like this poses the most significant risk to client returns in the coming years.
After all, we are no longer in the zero-interest rate era, which funded a considerable amount of the growth in the US. Interest rates are rising, credit card delinquencies are increasing, and savings rates are getting depleted. Still, instead of focusing on these factors, UK and US investors continue to plough money into the same markets as they had previously.
So, what will it take to change the mindset?
No sweat
Within the US, there isn’t the same degree of media-imposed headwinds as in the UK. Instead, they hear positive news about wage rises and low unemployment. At the same time, many are unaffected by rate rises as they have 30-year mortgages, all leading to a feel-good factor for US investors.
Additionally, US retail investors are the only ones who haven’t capitulated yet. In contrast, investors in the UK, Europe, China, and many other countries have experienced large parts of their client base throwing the proverbial towel in. The famous, and some might say infamous, Arc ETF is the poster child for this hard-wired dip buying. As longer-term investors, we all understand that a stock can drop 50% and then 50% again and again and still remain poor value. Something that many newer investors have yet to experience in the lower for longer era.
Looking back to the period between 2000 and 2008, it took almost two and a half years for tech to unwind. As we currently stand, there is little evidence that the lower for longer era will return anytime soon, barring an all-encompassing financial meltdown.
Not only does this potentially explain the continued apathy to investing in many UK assets, but it might also explain the rally we have seen in the US since the turn of the year. We believe this bounce will likely be short-lived. The economic data hasn’t been that good, but because there have been signs that inflation is possibly rolling over, markets hope the Fed will pause in its tightening cycle.
We would caution investors against leaning too heavily into hoping we return to pre-inflation market conditions. We have already seen increased levels of volatility as markets wrestle with, in some cases, historically unique market conditions, and those investors that fail to adapt, or continue to buy the dip in expensive assets, could face a prolonged and challenging period.
Y’all better hold tight
Looking at what has happened in the US regarding the failed Signature and Silicon Valley Banks and Europe with Credit Suisse, the one read across from a multi asset perspective is that there will be ongoing unforeseeable events. In such conditions, if you run concentrated positions, there is an increased chance of being disproportionately hurt by such an outcome.
One major concern is that the central banks take their foot off the gas by being persuaded to stop increasing interest rates. It echoes very similarly to the 1970s when inflation was pronounced dead prematurely, only to come back aggressively and force the federal reserve to slam the breaks on the economy in spectacular fashion.
I listen to hours of podcasts by very smart people, often economists and historians, whom all said printing money would have inflationary impacts. In short – you cannot print money with impunity without, at some point, facing inflationary consequences.
All the interventionist policies we have seen, both in bailing out the banks and central bank policy, have knock-on effects in the future. Like the Millennium Bridge, it looked like it would work in theory, but when the feedback loop begins, things can become very volatile very quickly. In this environment, it pays to be diversified and to look for opportunities away from those areas which could be most acutely affected, i.e., avoid the siren call of the regions/sectors that most benefitted from the lower for longer period. We remain underweight the benchmark position in US equities, but it remains our largest single-country holding.
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