Why the US exceptionalism trade is faltering

NEW YORK: Going into the year investors were betting that President Donald Trump’s policies would spur US stocks and the dollar to outperform their global peers. That assumption is increasingly getting tested.

The Trump administration’s revamp of the government and massive moves on trade and other policies have instead injected uncertainty, with consumers and businesses worrying about the economy, threatening the narrative of US exceptionalism.

The policy uncertainty is “leading to a dynamic ... where you start to see investors and business leaders and consumers alike kind of reining things in a little bit,” said Garrett Melson, portfolio strategist at Natixis Investment Managers.

“That’s against the backdrop that, aside from all the policy and the Trump administration noise, was already on a cooling trajectory” for the US economy, he added. In addition, the country’s megacap tech and growth companies that drove much of the market’s gains in recent years have faltered on valuation concerns and fed by worries over the DeepSeek low-cost Chinese artificial intelligence model. One ETF tracking the so-called ‘Magnificent Seven’ group has fallen more than 10 per cent from its high in mid-December.

Nvidia, a critical member of the ‘Magnificent Seven’ group, forecast first-quarter revenue above estimates on Wednesday, while the semiconductor company’s margin outlook was slightly lower than expected, in a report that was primed to set the tone for markets on Thursday.

Heading into 2025, US equities and the dollar were widely expected to outstrip their foreign counterparts. So far this year, however, the US benchmark S&P 500 has risen just over 1.0 per cent against a roughly 7.0 per cent climb for an MSCI index of stocks in over 40 other countries, while the greenback has slid about 3.0 per cent from its January peak against a basket of its main rivals.

Some of the diverging performance stems from developments outside the US, including surprising economic data in Europe and the emergence of an AI model in China that has shaken the technology sector, which has an outsized presence in US stock indexes.

However, worries about the domestic growth outlook have heightened after recent weak indicators from consumers and businesses, amid a barrage of announcements regarding trade and federal workforce cuts from the Trump administration, compounding concerns about the impact of still-firm inflation on the Federal Reserve’s interest rate path.

The latest economic reports could help drive a long-awaited catch-up for international assets, which have grown increasingly cheap compared with their US rivals. For example, on a price-to-earnings basis, the S&P 500’s premium over the MSCI index of stocks outside the US reached its highest in more than two decades in late 2024, according to LSEG Datastream.

Among the worrisome signs in the US economy over the past week are a release on Tuesday showing consumer confidence falling at its sharpest pace in 3-1/2 years in February, and a separate reading that showed consumer sentiment dropping to a 15-month low.

A survey on Friday showed business activity sank to a 17-month low, with activity nearly stalling in February. “The expectation has been for the U.S. (economy) to continue to do very well,” said Paul Nolte, senior wealth adviser and market strategist at Murphy & Sylvest Wealth Management, who at the start of the year tilted a global equities portfolio more towards stocks outside of the US.

“So if there is some fault with that, then maybe some of the valuation excess that the US has needs to come down closer to where the rest of the world is.” Recent weakness in US economic data has spurred investors to ascribe incrementally higher probability to a “growth scare” scenario, Charlie McElligott, managing director of cross-asset strategy at Nomura, said in a note on Monday.

Investors seem to be “getting their arms around” the implications of the initial Trump administration policies and starting to account for a far more serious growth drag than initial post-election narratives had suggested, he said.

Other indicators also may reflect a cloudier corporate outlook. The National Federation of Independent Business’s survey for January found the percentage of its small business members planning capital expenditures within the next six months dropping to the lowest level since before the November election.

The value and total number of announced US deals fell by about a third over roughly the first two months of 2025 compared with the same period a year earlier, according to Dealogic, even as the administration has been expected to provide a friendlier regulatory environment for mergers and acquisitions.

“Another month or two of poor US economic data would deliver a blow to the US exceptionalism narrative” and be a downside risk for the dollar, strategists at BBH said in a note on Tuesday.

European stocks generally have surged to start the year, with the continent-wide STOXX 600 index rising 10 per cent so far in 2025. Recent corporate profit growth in Europe is exceeding expectations by a greater extent than it is in the US, said Michael Rosen, chief investment officer at Angeles Investments.

His firm has been “aggressively overweight” US equities for most of the last 15 years, but in the near term, has moved more heavily to European shares, Rosen said. “There’s just more evidence that the very strong economic performance that we’ve seen in the US is beginning to diminish a bit,” Rosen said.

Indeed, the US exceptionalism trade was “too crowded” following the election, said Keith Lerner, co-chief investment officer with Truist Advisory Services, paving the way for at least some reversal to start the year.

Despite the shakier start for US assets, many investors may not abandon the trade. While the US economy was showing signs of weakness, many investors said risks of a near-term recession remained low while the economic benefits from Trump’s policies could come later in the year.

If the US economy does struggle, at some point the weakness would likely spread elsewhere, investors said. “If the US catches a cold, the rest of the world is going to get the flu,” Nolte said.

The Magnificent Seven companies have business models that many investors say can weather economic weakness better than other industries, which could support the US market in a global slowdown. The Magnificent Seven “stocks are not cheap... but their leadership is not in question,” said Phil Blancato, chief market strategist at Osaic.