One thing is clear: if you rely on the US for anything – demand for your exports or supply of critical high-tech products such as advanced semiconductors, financial aid or military protection – you could be increasingly at risk of being strong-armed by the new US administration. This situation is creating havoc in the short run, but in the long run it will create a new world order with a dramatic reduction in the US' influence across the globe.
The first thing I want to point out is that this is not a rant against the new US administration's policies. Some of what is being proposed makes total sense. For instance, it is easy to argue that Europe should have been spending a lot more on its military capabilities when arguably it faces the biggest risk to its borders.
However, what is undeniable is that the US has huge leverage over much of the world given its economic, political and military power. The difference now is that the new US government is more willing to use this leverage to strike deals with various countries that are beneficial to the US and detrimental to their counterparties. In the short term, US allies and adversaries don't really have much of a choice. Of course, they can and will push back in different ways to try to get better terms, but deals will be done. In the long run, the message is clear. Everybody needs to recalibrate the extent to which they are comfortable being reliant on the US.
Implications of more transactional US foreign policy
On the trade front, this means relying less on the US consumer. Trump’s interpretation of the US’ soaring current account deficit is that non-US countries have been manipulating the trade rules to their benefit and the US’ detriment. An alternative view is US consumers’ willingness to consistently spend more than they earn, which was aided by the extraordinary fiscal boost since the pandemic, has been the cause of the deficit (more than 3 percent of GDP). These goods demanded by US consumers must be produced by somebody and the rest of the world is more than willing to step in to fill the void left by the US industrial economy, which remains at close to full capacity.
A more transactional US foreign policy also means identifying key vulnerabilities in supply chains, particularly any overreliance on one country, especially the US. While the US wants to export more to other countries, any such overreliance can also be used as leverage to extract concessions at a later stage.
Finally, for Europe, it also means spending more on the military, again ideally on equipment and technology produced locally or regionally, rather than in the US.
Implications for investors
What this means for investors is that while deals are done in the short term, it probably implies that US exceptionalism continues.
However, over the long term, the whole economic and geopolitical order could gradually be re-engineered. This prospect presents opportunities for economies around the world, such as Europe, China, Russia and the Middle East.
Given the extreme valuation differentials between the US and the rest of the world, this is potentially extremely important.
The narrative up until the beginning of this year was summed up by "TINA," i.e., there is no alternative to US assets.
However, the sanctioning of the Russian central bank in 2022 challenged this to some extent as it sent shockwaves through the central bank community. Central banks of economies that are not fully aligned with the US' world view have been scrambling to try to reduce their reliance on US assets (something that is really challenging, given that the depth and liquidity of the US government bond market is still unrivaled). Gold appears to have been the primary beneficiary of this shift in central bank demand so far.
Case for diversification
Meanwhile, for equities, increasingly aggressive US policies could prove to be the catalyst for reshaping the growth drivers of companies, industries and countries over the coming years and decades in ways it is difficult for us to fathom today.
Add in the "you're either with us or against us" atmosphere and it is easy to see some US companies suddenly falling out of favor, sharply curtailing their prospects. Such uncertainties usually lead to lower valuations (price-earnings ratios).
Therefore, the current overrepresentation of US financial assets in global indices may be in the process of peaking. As with the adage about bankruptcy, this will likely happen very slowly and then all of a sudden.
For over a decade now, long-term expected returns have been higher for non-US equities, and US equities have outperformed regardless. Maybe this is about to change. For us, the key barometer will be the US dollar. As with other US assets, the US dollar is overvalued. If it were to break decisively below the range it has traded since late 2022, and there are whiffs of that in the past week, this situation would likely herald a strong outperformance of non-US assets. Therefore, it is important not to neglect non-US assets in your portfolios.
Steve Brice is the global chief investment officer at Standard Chartered Bank’s Wealth Solutions unit. -- Ed.
jwc@heraldcorp.com
