U.S. Stocks Have Trounced Other Markets. Here Are 3 Risks to American Exceptionalism.
The U.S. stock market continues to stand out as the place where investors can generate the most attractive returns, lending new meaning to the term “American exceptionalism.” In the past 12 months, the S&P 500 has risen 24.3%, compared with gains of 12.45% in the Stoxx Europe 600 index and 14.81% in the MSCI Emerging Markets index.
The U.S. now represents nearly 70% of the world’s equity-market valuation, and more than 70% of the net investment flows into the $13 trillion global market for private investments, including equities and credit.
These trends are pushing U.S. asset valuations to extremes relative to the rest of the world, as the outperformance of the U.S. has accelerated over the past decade. But investors repeatedly have brushed off warnings of a financial bubble, just as the market has shrugged off concerns about things like tariffs that might have triggered selloffs in the past.
At what point do growth expectations and valuations get so large, however, that investors head for the exits? A number of factors could prompt a retreat from U.S. market exceptionalism.
One is valuation. The S&P 500 currently trades for 24.9 times this year’s expected earnings, compared with a historic price/earnings multiple of 16.
There may be fundamental shifts in the economy, such as productivity gains from AI, that support these higher valuations and mean traditional multiples no longer apply. Productivity gains and innovation could lead investors to believe that businesses can sustain growth for longer, thereby justifying a higher valuation than traditional metrics and analysis would suggest. But, at some point, the market’s P/E ratio will fully reflect those expectations.
Persistent inflation could also pose problems for companies and stocks. The Trump administration’s deportation of undocumented immigrants and a projected reduction in immigrant flows are likely to put upward pressure on U.S. wages, while higher tariffs on trade could boost consumer prices for steel and energy. The 4.5% yield on the 10 year U.S. Treasury reflects market concerns that inflation isn’t yet sufficiently subdued, and could revive.
A third potential trigger for a material market selloff is the U.S. government’s worsening fiscal situation. Scott Bessent, the new Treasury secretary, has set a “3-3-3” target of 3% average annual growth in gross domestic product, three million barrels of additional daily oil production (up from a current 21.6 million barrels a day), and a reduction of the U.S. budget deficit to 3% of GDP.
Investors are likely to hone in on the Trump administration’s progress in reducing the budget deficit, in particular, as the deficit now stands at 6.4% of GDP and is expected to rise. Efforts by the Trump-authorized Department of Government Efficiency, or DOGE, to cut government spending by $2 trillion could help move the deficit-to-GDP ratio toward Bessent’s goal.
Although the U.S. dollar enjoys reserve-currency status, both the large deficit and the current debt-to-GDP ratio—not to mention annual interest expense of roughly $1 trillion on government debt—are a concern for markets. Investors could be spooked if there isn’t at least a material dent in projected debt levels and the deficit.
Finally, there is a risk that, given the rapid growth in private credit, leverage in the financial system could become a drag on the broader economy, as happened during the 2008-09 financial crisis. According to S&P Global, so-called shadow banks, or non-bank lenders, held $63 trillion in financial assets globally at the end of 2022, representing 78% of global GDP. Markets likely would react vigorously, and negatively, to any hint of a credit crunch.
On a structural basis, the U.S. is hard to bet against. It is the world’s strongest economic bloc and a producer of low-cost energy. Its risk-taking culture, combined with deep capital markets, will continue to drive technological innovation, and allow companies to develop and grow to scale. These factors place a floor on the value of U.S. assets.
It is impossible to know how high U.S. asset prices will rise. But investors must remain alert to the potential risks that could spur a new wave of market carnage.