US: Big Bubble, So Big Trouble

The idea of America as an exceptional nation, superior to its rivals and therefore destined to lead the world, now seems passé to most observers. In political, diplomatic and military circles, the talk is of an increasingly dysfunctional superpower, isolationist abroad and polarised at home. But in the investing world, the term “American exceptionalism” is hotter than ever.United by faith in the inherent strength of US financial markets and their capacity to keep outperforming all other economies, global investors are committing more capital to a single country than ever before in modern history. The US stock market now floats above the rest, with relative prices at a record since data began over a century ago, and relative valuations at a peak since data began more than half a century ago.As a result, US accounts for nearly 70% of the leading global stock index, up from 30% in the 1980s. And the dollar, by some measures, trades at a higher value than at any time since the developed world abandoned fixed exchange rates 50 years ago.The overwhelming consensus is that the gap between America and the world is justified by the extraordinary earnings power of top US companies, their reach into the remotest corners of global trade, and their leading role in tech innovation – with AI the latest case in point. These strengths are real, but one definition of a bubble is a good idea gone too far – and awe of “American exceptionalism” has now gone too far.America’s share of global stock markets is far greater than its 27% share of the global economy, and the arrival of Donald Trump has only reinforced this disconnect. Investors believe his plans to raise tariffs, lower taxes and cut regulations will further inflate US markets, which had been outrunning the rest of the world since the end of the global financial crisis in 2009.America’s exceptional qualities were long since priced in, and then came Trump’s victory in November, when US put in its strongest month of outperformance yet.It’s as if America is the only nation still worth investing in. This is not a bubble within the US market, it is a mania for America within global markets. At the peak of the last tech boom in 2000, US stocks were more expensively valued than they are now, but the US market did not trade at nearly so vast a premium to the rest.The difference is striking: in the dotcom era US prices peaked slightly (well below one standard deviation) above trend relative to the world; now they are super-normally high at 3.3 standard deviations above trend.Compared to Europe and Japan, the US economy is growing faster, so some of the premium is rational. Compared to many developing nations, the US economy is growing slower, yet it commands a premium not seen since the depths of the financial crisis that gripped emerging markets in 1998.Travelling recently in Asia and Europe, one came across investors everywhere who seem overawed by the global giant. In Mumbai, financial advisers are pressing their clients to diversify outside of India by buying in the one market that’s even more expensive – America. In Singapore, the host of a lunch with wealth managers asks the crowd: “Anyone here who does not own Nvidia?” Not a single hand goes up.But this is also not just AI mania by a new name. On indexes that weight stocks equally regardless of size and thus correct for the domination of Big Tech, US has outgained the rest of the world by more than four to one since 2009. America’s drawing power in the global debt and private markets is even stronger.So far in 2024, foreigners have poured capital into US debt at an annualised rate of $1tn, nearly double the flows into the Eurozone. And US now attracts more than 70% of the flows into the booming $13tn global market for private investments, which include equity and credit.Though observers who watch the world from a geopolitical perspective think it is increasingly multipolar, investors think it is increasingly unipolar – and that makes the markets a zero-sum game. In the past, including the roaring 20s and the dotcom era of the late 1990s, a rising US market would lift other markets. Today, a booming US market is sucking money out of the rest of the world.Investors still like to believe that fundamentals drive prices and sentiment, but there comes a time when the feedback loop reverses, and sentiments get so high that it starts to drive fundamentals. As money leaves smaller markets, the outflows weaken the currency, force the central bank to raise rates, slow the economy and make the nation’s fundamentals look worse.Talk in the markets and the media about possible bubbles in tech or AI, or in investment strategies focused on growth and momentum, is obscuring the mother of all bubbles. Thoroughly dominating the mind space of global investors, America is over-owned, overvalued and overhyped to a degree never seen before. As with all bubbles, it is hard to know when this one will deflate, or what will trigger its decline, but I will sketch some of the possible scenarios in my next column.