Market pricing reflects renewed complacency 

Market action in April was nothing short of spectacular. After a waterfall decline, the S&P 500 Index is giving the Trump administration the benefit of the doubt for now. In fact, both the flagship US equity index and global equities have recouped the entirety of their so-called ‘Liberation Day’ drawdown, while the latter are even positive year to date when measured in USD. However, not all corners of the market have jumped back as enthusiastically. Oil and the US Dollar Index are still muddling through. The riskiest segments of the credit markets have also been slower to recover. The spreads of publicly listed business development companies (BDCs), our favourite proxy for private credit performance, have yet to recover their post-2-April widening. In our view, this divergence between higher- and lower-quality assets is indicative of something beyond tariffs that is going on below the surface. After all, the market had topped and credit spreads had started widening already back in February.

Admittedly, retail investors who enthusiastically bought the tariff-induced dip helped US equities to bounce back. The largest S&P 500 exchange-traded fund saw a record inflow of nearly USD 21 billion in April, the biggest in its 15-year history. The rebound reflects hope that rests on some sort of pragmatism eventually returning to the White House. In other words, the expectation is that President Trump is simply using the announced tariffs as leverage in trade negotiations but that he will continue to announce ‘beautiful’ trade deals with key trading partners.

Above and beyond the potential headwinds from an imminent economic downturn caused by a wilful wrecking of global supply chains, the US has not secured any viable alternatives. China is no longer about having access to low labour costs. Multinationals, including those headquartered in the US, have built highly sophisticated supply chains to sustain their operations in China over the past few decades. Experts agree that a complete relocation of such deeply rooted ecosystems to the US is not only impractical but outright unfeasible in most instances given the lack of an adequately skilled workforce in the US.

Is this the end of globalisation as we know it?

Since the abolishment of the fixed exchange rate regime that marked the beginning of the Bretton Woods II era in 1971, the US dollar has seen successive secular bull and bear cycles. Since the Global Financial Crisis in 2008, the USD has been on a secular uptrend. Over the same period, US equities have massively outperformed their rest-of-the-world counterparts, largely driven by a few US mega-cap stocks that were among the big globalisation winners. Indeed, besides an outstanding performance track record, US equities have also provided investors with the broadest exposure to exponential-growth business models, which are found only selectively – or not at all – in other markets. As a result, US dominance in global benchmark indices has reached unprecedented levels. Put differently, non-US investors have accumulated record exposure to US assets in their portfolios over the last 15 years. Today, the Trump administration’s policy actions are shaking the Bretton Woods II regime to its foundations. This means that there is a risk that we are transitioning from a secular bull cycle to a secular USD bear cycle, simultaneously marking the end of the secular outperformance of US assets.

US policymakers have limited room to manoeuvre

The tariffs announced on 2 April constitute an external shock, with inflationary effects in the United States and deflationary effects in Europe and Asia. The US finds itself in a difficult situation in responding to this shock, both in monetary policy (more accommodation would mean adding to inflationary pressures triggered by the tariff- induced negative shock to domestic supply) and in fiscal policy terms (the US is still running a record budget deficit and has prescribed itself a fiscal detox). Europe, China, and other Asian countries, conversely, have the means to support their economies. Admittedly, we have no short-term visibility given the political nature of the dominant factors and in the context of a US administration that is subject to multiple, and sometimes radical and totally un-predictable, U-turns.

Should we worry about a capital war?

Fundamentally, since the US is playing a bad hand here, the million-dollar questions are whether the current trade war will evolve into a capital war and whether the US government will begin to use repressive financial measures to improve the country’s finances. Conceptually, the US wants the rest of the world to pay its fair share for the provision of the US military umbrella, as well as cooperation in containing the rise of China. In other words, tariffs are just part of a broader toolkit in the US administration’s attempt to counter the US twin deficit and safeguard US hegemony. Should the tariffs prove ineffective, it cannot be ruled out that the US administration will resort to alternative measures. They might decide to impose a user’s fee on foreign US Treasury security holdings or enforce mandatory conversions of existing holdings to instruments with longer maturities, potentially up to 200 years, up until repayment occurs. Such an outcome poses a serious risk for global capital markets. Today, nobody’s asset allocation is strategically positioned for entering such a radically different investment environment. Non-US investors should reconsider the extent of capital they want to strategically allocate to a market where the risk of confiscation has increased.

Global portfolios are still heavily tilted towards US assets 

From a global asset allocation perspective, it cannot be stressed enough that the starting point matters. US dominance in global benchmark indices has reached record levels. The US makes up more than 70% of the MSCI World Index, exceeding the previous peak reached in the 1970s Nifty-Fifty era. The phenomenon extends to global government bonds (where the US’s share is close to 50%) and to private markets (where the US’s share is north of 50%). At the same time, non-US investors own USD 19 trillion in US equity, USD 7 trillion in US Treasuries, and USD 5 trillion in US credit. This is equivalent to 20% of the total US equity market capitalisation, 30% of the total US Treasury market, and 30% of all US credit outstanding.

A large-scale rerouting of non-US capital has major investment implications. A simple halt to the inflows of non-US savings into US capital markets would put severe downward pressure on the US dollar and increase the US cost of capital, bringing us closer to a capital war, since it would mechanically increase US Treasury yields. If these flows were not only to be halted but also to go into reverse, with capital structurally fleeing rather than seeking shelter in the US – as was the case in the 2000s when we saw the last secular USD bear market (August 2001 to March 2008, with a second bottom in April 2011) – the impact on US assets would be considerably larger given the extreme starting point nowadays. Donald Trump returned to power with a new policy agenda, accelerating the shift towards what looks increasingly like the beginning of a protectionist era after eight decades of globalisation.

Conclusion – reconsider asset allocation 

In the short term, the ‘pain trade’ for US equities remains up, which is why we are refraining from further decreasing our equity allocation for the time being. To quote a strategist from one of the largest asset management firms in the world, with whom we were recently exchanging market views: ‘We don’t feel like standing in front of the US retail crowd flows.’ Nevertheless, we continue to believe that we are currently witnessing the early innings of a bear market in US equities. As a result, investors should use intermediate recovery episodes, such as the one currently unfolding, to further diversify their portfolios away from US capital markets. While uncertainty stands to prevail as volatility spills over from the White House into financial markets, one thing is clear: the recipe for successful investing in the future will no longer be the same as it has been over the last 15 years.