US share prices staged a sharp rebound this week on the announcement of a rapprochement between the US and China on trade barriers.
By the time markets closed on Tuesday, the S&P 500’s losses since the start of the year had been wiped off. That followed news the US had cut proposed tariffs on Chinese goods from 145 per cent to 30 per cent for 90 days, and some better than expected inflation data.
The news changes very little, however. Many investors have recognised that diversifying from US dollar and equities exposure makes some sense, especially given the muted rebound in the US dollar and the rising long bond yields in the US.
Investors have watched the US president issue important and potentially damaging trade policies against the country’s third-largest trading partner before reversing course, all within roughly a month. They may also be questioning the superiority of America’s capital markets.
Erik Knutzen, co-chief investment officer on multi asset strategies for Neuberger Berman, an investment group, says the rollback of the highest tariffs still means current US trade policy is that of the 1940s — when rates were around 10 per cent — rather than the disastrous, higher ones of the 1930s.
But he adds: “We don’t feel the US equity market is the right place [to focus on] now.”
Even putting aside the volatility in US trade policy, Trump’s America First policies should accelerate de-globalisation, which could lead to both higher prices for importing countries and slower economic growth for the US and its trading partners.
More importantly, investors everywhere are, perhaps for the first time in decades, reconsidering America’s role not just as a defender of peace but as a safe haven for mooring their money.
The warning signs have been there. First, the outperformance of US equities has meant that they have come to dominate global indices such as MSCI’s world index, which many institutional investors follow.
Second, that dominant position has encouraged flows into the US dollar. By January this year, according to the Federal Reserve’s data series, the dollar was at its strongest versus other currencies since 1985.
Finally, the two have come together as a shift towards passive investment in global indices has enabled both equity and currency gains concurrently.
In the five years to June 2024, foreign portfolio holdings of US securities — both equities and all types of debt — rose by $10.3tn, according to the US Treasury. A phenomenal change in share holdings alone made up over $8tn of that. The market value of the FTSE All-Share index, by comparison, is $3.5tn.
John Butler, macro strategist at asset manager Wellington Management, points out that around 50 per cent of global savings held abroad by investors are currently invested in US assets.
“This should result in net capital outflows out of the US and into other markets,” Butler says. “This has structural implications for the US dollar, equity and bond markets.”
In a taster of what could happen, foreign capital shifted to Japan’s markets during the turmoil that followed the White House’s tariff announcements on “liberation day” last month. Data for April, released this week by the Ministry of Finance, revealed that foreign investors had bought a net ¥8.2tn ($57bn) of stocks and bonds.
That was the most in any month since 2005 and far above average for April. According to one US money manager with large Japanese institutional clients, the shift reflects a pause in buying of the dollar and US Treasuries, rather than a sell-off of US assets. The dollar remains about 8 per cent below its January high.
This summer could bring the next test for investors. US inflation and jobs data in the next few months could offer a catalyst for further shifts away from the US dollar, according to Noah Wise, head of global macro strategy at Allspring Global Investments, an asset manager.
So far, only US survey data, such as the Institute for Supply Management’s views of purchasing managers in various industries, has shown any significant reaction to the trade tariff increases.
Many observers regard these data series as relatively unreliable, or soft. But the hard economic data, such as that on unemployment and industrial production, reflects an earlier period and so far gives no warning signs. Price inflation in the US has remained moderate, a bit above 2 per cent annually.
However, by late summer any US hard data releases covering the impact of Trump’s trade policies should be in the public domain. This will come at the same time as the 90-day pause on any additional trade tariffs on China is due to finish. Any poor economic data, combined with another flare-up of the US-China trade disputes, could bring a return of market volatility.
Wise points out there is also little immediate prospect that the US Federal Reserve — the Fed — will cut interest rates.
“US inflation is above target today and over the next six months is going to move further away from target,” Wise says. “Until hard economic data suggests a clear slowdown, the Fed is unlikely to cut rates.”
This does not mean that US capital markets are doomed. Wise believes any talk that foreign investors will discard their holdings in US Treasury bonds is premature.
“Could foreign investors take their assets away?” he asks. “I’ve been hearing this for decades. But what are their options? Are they going to pile into [Japanese] or Chinese bonds? Probably not.”
That echoes the views of Neuberger Berman’s multi-asset team, who feel that there is insufficient liquidity in Japanese government bonds, particularly long-dated bonds, to shift capital towards them.
Something is changing in the US bond market, however. There is evidence that the least price-sensitive holders of US Treasuries have reduced their exposure in recent years. This group includes reserve managers at central banks and sovereign wealth funds, all generally considered to be highly conservative. As of the end of April this group owned just over 36 per cent of all US debt, according to data from JPMorgan asset management and the Federal Reserve. That is near the bottom of the historical range since 2012 and well below the highs of around 47 per cent.
For equity investors, this year was the one to seek some diversification. The US market traded at 27 times forward earnings by February this year, not far from a decade high, according to MSCI data. Although analysts have long worried about the persistent valuation premium to other world markets, it was only this year that a catalyst for change became visible. Even after a drop in the market’s value since February, the US market remains expensive internationally.
Furthermore, the analysts who estimate earnings for US companies have yet to reduce their earnings expectations significantly. That may be because US economic data so far has not revealed any worrisome trends.
But some investors see a change coming.
Hugh Gimber, global strategist for JPMorgan Asset Management, says he is finding it hard to reconcile current US earnings estimates with the potential for US growth.
“[Previous] analyst consensus estimates of 14 per cent earnings per share growth for 2025 have only slowed to 9 per cent growth,” Gimber says. “I would be expecting low single digits instead.”
Equity and currency markets began to reprice the riskiness of US exceptionalism before the tariff announcement.
Helen Jewell, BlackRock’s Emea chief investment officer for fundamental equities, points out that the trend started with the news in late January about the greater than expected capabilities of China’s DeepSeek AI model. The news about DeepSeek — a rival to the US’s Open AI — was a reminder that the US had no monopoly on technologies like AI, Jewell says.
She believes there is further scope for European equities to be re-rated against the US.
“There was a 45 per cent discount on the valuation of European names, which is now 30 to 35 per cent,” she says, comparing European values against those in the US. “Historically, the discount is 20 per cent.”
Jewell says that shares in European banks, despite a strong price performance this year, remain cheap. But she predicts that overall the discount may not fully return to the previous average. Trading at around 14 times forward earnings, current European stock values are “about right over time”, she says.
“It’s not about European stocks trading cheaply,” she says.
JPMorgan’s Gimber, meanwhile, sees potential for more growth in Europe, thanks to growing investment levels.
“In 2010-19 European investment was tiny but it is now growing at an 8 per cent clip,” he says. “This is a transformational change, and that has to be a positive for nominal growth and more robust earnings growth for European corporations.”
Such sentiments have prompted shifts in some portfolio managers’ allocations. According to the latest edition of Bank of America’s widely followed fund manager survey, investors are more overweight in Eurozone equities compared with the US than at any time since October 2017. Many continental European indices have performed well this year against their US counterparts.
Yet the shares of UK small and mid-cap companies have been laggards. The FTSE 250 index, for the 250 companies immediately below the FTSE 100 index of the largest companies, is up only about 6 per cent this year in US dollar terms. The FTSE 100 is up about twice as much.
The FTSE 250’s underperformance hints at investor concern about the UK economy’s potential for expansion, rather than the companies’ size. Europe’s Stoxx ex-UK small-cap index has outrun both the FTSE 250 and the FTSE 100, gaining nearly 17 per cent this year.
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Nevertheless, some portfolio managers are bullish about the UK. The country’s GDP grew by a stronger than expected 0.7 per cent in the first quarter. The growth was the fastest in a year and faster than that seen in Europe.
Alec Cutler, who runs nearly $4.6bn in balanced global equity and bond mandates in the Orbis Global Balanced fund, says that President Trump has done the UK and Europe a “massive favour”. He has favoured UK stocks because of their low valuations and holds just 10 per cent of his portfolio in the US.
“We’ve been extremely underweight in the US and made up for that in the UK and Europe,” Cutler says.
He adds that the processes that Trump has begun should boost demand for steel, aggregates and infrastructure construction groups such as Balfour Beatty. He also holds Keller, which designs and installs specialist foundations for buildings.
In addition, having held defence stocks for several years, Cutler has 10 per cent of his portfolio in defence stocks, including Italy’s Leonardo.
He insists such shares remain keenly priced if European leaders fulfil their commitments to boost their military spending from the current level, of around 2 per cent of GDP, to around 3 per cent. He has added South Korean, Indian and Japanese defence names more recently.
UK equity specialists Julian Cane and James Thorne at asset manager Columbia Threadneedle point out that while UK disposable income has been growing at a low double-digit pace year-on-year, consumer confidence has waned. As a result, the savings rate in the last quarter of 2024 had rebounded to 12 per cent, the highest since the second quarter of 2021.
Recently, as a result of tepid earnings growth, the FTSE 250’s trailing earnings multiple has fallen to a historically low multiple of 16 times, while the price-to-book ratio has fallen as low as 1.5.
Jewell at BlackRock remains sceptical about the UK, pointing out that 85 per cent of the market capitalisation of the FTSE All-Share index comes from the FTSE 100, suggesting smaller companies are enjoying little benefit from falling interest rates.
“Small caps . . . are a very small part of a small global market,” she says. “Valuation expansion is not happening. It’s all earnings driven.”
There are wider investor concerns about a number of other areas in the world economy. There is no immediate prospect for a return of investor confidence, despite the past week’s reprieve for China on some tariffs.
Some analysts believe the shocks of recent months have still to be fully felt in US share prices.
JPMorgan’s Gimber says that prices in the US market are still not discounting for the effects of the rise in trade tariffs, pointing out the continuing uncertainty that many face.
“If you’re a large corporation, why would you initiate plans on building a new plant or make major hiring decisions?” Gimber asks.
