The world is growing nervous about U.S. assets and for good reason.
Over the past 15 years, money from around the world has poured into U.S. stocks and U.S. bonds. That has led to a dramatically unbalanced situation in which nearly everyone everywhere has a financial stake, direct or indirect, in what happens in the United States, while the U.S. has only a passing interest in what happens elsewhere.
Unless you’re a market junkie, you may not realize how dramatic this shift has been. The numbers, though, tell a striking story, particularly in the case of U.S. stocks.
Back in 2010, U.S. stocks made up 48 per cent of the MSCI World stock market index – a hefty but not overwhelming share of the global action.
Now, the U.S. share of that benchmark has surged to around 72 per cent.
In practical terms, that means anyone who buys a global stock market index fund is really buying a U.S. fund in disguise. From an investor’s perspective, the world outside the U.S. has dwindled to little more than an afterthought.
Is this a great idea? Probably not.
The risks of betting so much of the world’s wealth on a single country are surging now that Washington is in the hands of incompetents. Donald Trump’s on-again, off-again tariffs underline how incoherent his economic agenda is. Meanwhile, the enormous U.S. budget deficit continues to swell on his watch, raising concerns about how much longer the rest of the world will be willing to finance Americans’ extravagance.
The foreign-exchange market is already registering its concerns. The U.S. dollar has lost about 8 per cent of its value against other major currencies since Mr. Trump was inaugurated.
This is an extremely unusual development. People usually flock to the safety of the greenback in times of economic tension.
Not this time, though. Despite all the international friction over trade and rising yields on U.S. government bonds – both things that would normally be expected to propel the U.S. dollar higher – investors are headed for the door.
Many expect this exodus to continue. In the most recent edition of Bank of America’s widely followed Global Fund Manager Survey, a net 61 per cent of big investors said they expected the U.S. dollar to depreciate over the next 12 months. That is the most bearish that large money managers have been on the greenback since 2006.
The darkening sentiment seems to be going hand-in-hand with fading confidence in the administration. In just three months, Mr. Trump has managed to trash much of the credibility that the U.S. has spent decades building up. As many commenters have observed, his country is starting to resemble a banana republic. Out-of-control leader? Check. Fraying rule of law? Check. Precarious financial situation? Double check.
The U.S. budget deficit is expected to surpass 6 per cent of gross domestic product this year. Budget gaps of that size used to occur only during emergencies such as wars. Now they are occurring in peacetime and with no end in sight.
If the Republican majority in Congress continues on its current course, Washington’s deficits over the next decade will swell by trillions of dollars and the accumulated debt of the U.S. will climb to historic heights when measured against the size of the country’s economy.
The prospect of runaway deficits is already undermining the greenback’s privileged position as the globe’s ultimate safe asset. Recent market upheavals suggest that “investors [have] started to question the role of the dollar as the reserve currency,” according to a note this week from Zhengyang Jiang, a finance professor at Northwestern University’s Kellogg School, and several colleagues.
The growing doubts around the greenback mean that foreign investors are likely to demand higher yields on U.S. Treasury bonds as compensation for the increasing risk of holding U.S.-dollar assets. This is not good for U.S. equity prices because it makes bonds a more attractive alternative to stocks.
Unfortunately, Washington’s other option – cutting its deficit to restore faith in the greenback – doesn’t bode well for Wall Street, either. Any attempt to rein in the deficit is likely to result in lower corporate profits and thus lower stock prices.
What should investors take away from all this? One useful idea is to make sure your portfolio is not betting too much on an increasingly fragile-looking U.S. economy.
“Late last year, we suggested investors should begin diversifying away from the U.S.,” Beata Manthey, an equity strategist with Citigroup, wrote in a note this week. “Recent developments have reinforced this view.”
She argues that the U.S. is no longer the only game in town. Tariff frictions, the rise of China as a developer of artificial intelligence and Europe’s new willingness to spend on defence all suggest that investors may want to start looking for growth elsewhere.