The reasons to reduce your exposure to the world's biggest stock market are growing

Last week I asked whether the 60/40 portfolio had enjoyed its best days and suggested that investment success would now demand broader diversification than this simple equity/bond split. A related question facing asset allocators today is whether a bias towards US shares within the equity portion of such a balanced portfolio has also run out of road. Are we witnessing the end of American exceptionalism?

The list of reasons to reduce your exposure to the world’s biggest stock market is getting longer. The latest addition was well hidden in the 1,116 pages of Donald Trump’s ‘Big Beautiful’ budget bill. Clause 899 enables the US Treasury Secretary to levy a surcharge on US investments held in countries that are considered to have imposed ‘unfair’ taxes on US companies. It is this clause that could turn a war on trade into one focused on capital.

It's not hard to see why it should have been drafted. It is a lot easier to tax capital than trade in goods. Doing so is less susceptible to legal challenge once approved by Congress. America alone gets to decide, every three months, which countries are captured by its definition of ‘discriminatory’ taxes. And we’re talking big numbers. Thirty years of US market outperformance, and a strong dollar, have resulted in overseas investors holding US$26trn more in America than US investors hold overseas. That’s a big pool of assets to tax.

There are good reasons why the US would want to levy this kind of tax, especially if it is confident that the appetite of overseas investors for US assets will hold up. In addition to the cash that might be raised by a levy of up to 20 per cent, reducing global demand for American assets would, all other things being equal, reduce the value of the dollar - another aim of the administration.

One downside is that the ‘exorbitant privilege’ given to America by the dollar’s reserve status would diminish. When you owe US$35 trillion, having to pay a few basis points more to finance your debts is not a trivial consideration. The other obvious negative is that it would reduce the value of US assets as investors stopped seeing America as a safe haven and refocused their portfolios towards friendlier jurisdictions.

Clause 899 builds on two other reasons to consider reducing our exposure to the US. The first is the US$3 trillion or so that the rest of the bill is expected to add to America’s national debt over the next ten years. The price of funding those borrowings (adding to interest payments that already exceed the cost of the US military) is one of the reasons why investors are demanding ever more compensation for holding US government bonds out into a potentially inflationary future. When bond yields rise above 5 per cent, it is not just bad news for holders of those bonds but also for investors in shares, which offer an increasingly uncompetitive income.

This leads to a third reason to be cautious on the relative outlook for US investments - valuation. History suggests that when bond yields rise above 5 per cent investors balk at paying more than 20 times expected earnings for shares. Why would they, when they can earn a relatively risk-free income without the ups and downs of the stock market. Were the price-earnings ratio to fall back to the 17 or 18 times multiple at which shares become more obviously attractive, that would imply a 15-20 per cent correction, back from the top to the bottom of the Trump 2.0 trading range for the S&P 500.

This is the easy to digest narrative that investors are accepting at the moment. It is why the euphoric post-election flows into US equities abruptly stopped at the time of the early April tariff announcements and why Germany, for example, has reversed in a couple of months all its cumulative outflows since 2023. Investors prefer a simple story. And today’s is that US exceptionalism is dead and buried.

That might be an over-reaction. As investors, we have a tendency to extrapolate and overweight near term negatives. While I can find plenty to worry about in the Trump policy platform, I wouldn’t count on the President undermining the decades of advantages from which America continues to benefit. Here are four highlighted recently by Alliance Bernstein strategist Inigo Fraser Jenkins.

First, demographics. Unlike most big economies in the world, the US has a growing workforce. It is no longer expanding at the annualised 1.3 per cent it registered between 1980 and 2010, but between now and 2050 the US labour market is still expected to grow at 0.2 per cent a year. That compares with a fall of 0.6 per cent a year in Europe and 1 per cent in China. The size of the workforce, alongside productivity, is a key driver of GDP.

Second, corporate profitability. Higher profits flow from a number of sources. These include better use of technology, more favourable regulation and taxes, and a more dynamic risk culture. Profit margins have doubled in the US since the financial crisis.

Third, energy security. America drilled over 13 million barrels of oil a day in 2024, making it the world’s largest producer. It was a net energy exporter by 2019 thanks to Shale.

Fourth, the size of America’s homogenous domestic market. Although Europe is potentially a bigger and richer market, it suffers from a patchwork of national cultures, banking systems, rules and languages. The US financial markets are vast, too, providing unrivalled depth and liquidity.

So, while I worry about America’s withdrawal from global institutions, its willingness to make enemies of its friends, the undermining of its world class universities and the erosion of its soft, cultural power, I am not ready yet to call the end of America’s dominant position in financial markets. US exceptionalism was built over decades; I do not think it will crumble in a matter of months.

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Please note that the views expressed in this article are my own.