Hardy’s Macro View: Rule #2 for the Trump 2.0 market era.

Why have US stocks historically deserved a premium?
There are some very good reasons why the US equity market has outperformed its global peers. Let’s start with what makes the US market special.

Very large companies with high profitability and high growth rates. This is a straightforward one – the US is home to the largest, most profitable companies in history, six of which are in the so-called Magnificent 7 of what are currently the largest seven companies ever by market cap. Amazingly, these companies, and a significant number of companies of still very large size, have managed strong growth rates with high margins because they operate chiefly in the tech and communications services industries, and many have monopoly-like status within their industry. Within the Mag 7, the fastest share-holder value creation in history has been generated by Nvidia, whose AI chips have made it the world’s second-most valuable company currently at USD 3.2 trillion. That company is up more than 1,000% from its late 2022 lows. Of course, the very heavy weight of the US super-giants brings its own risks, as we talk about in the dangers for US equity market investors below. But consider this: in the 2014-2024 period, US S&P 500 companies grew their earnings by a total of 119%, while the European Stoxx 600 companies only grew earnings by 62% in the same period.

Passive investing. Passive investing is the practice of allocating funds to the market based on existing stock indices and the weight of stocks. This means that the winners are allocated more and more funds every month. Because the largest companies are found in increasingly popular ETFs that offer passive exposure to major stock indices, the whole setup serves as a kind of self-reinforcing feedback loop, with the US benefitting the most as it is the largest market with the largest, most successful companies.

Focus on shareholders. Nearly all of the most successful US companies are run by executives who are incentivized via stock options to ensure that the company’s shares are performing well. To reward themselves, and all shareholders, which often includes many other employees, companies often recycle profits and even occasionally loan money to buy back their own stock – a tax-efficient way to increase the value of each share. Take Apple, for example, one of the more aggressive companies in buying back its own stock. From 2014-2024, the company bought back over 8 billion of its own shares, reducing the shares outstanding by more than 35%.

Rule of law, market access and market transparency. The US has the deepest, most liquid market in the world, offers strong protections for investors and high standards for financial reporting. This is unlikely to change and will remain a key positive for the US.

Then what could threaten the US “exceptionalism” from here?

Now that we know some of the strengths of the US equity market, let’s consider some of the weaknesses.

Incredible concentration at the top. The US market has never been more concentrated, meaning that never have the largest handful of global companies made up a larger percentage of the overall US market. Within the S&P 500 index, which again is about 80% of the total US equity market capitalization, the Mag 7 alone represent nearly 32%. And if we look at the MSCI world index, an index representing all developed markets, the Mag 7 are over 20% of the entire global market. If anything goes wrong with a few of these companies, the major US market indices will suffer greatly.

The Trump agenda and the world’s response. As stated in Rule #1, President Trump is out to change the US position in the world. There are ways that this could benefit US companies, but perhaps more so, there are strong risks to all US companies and especially those that derive a significant portion of their revenues from abroad. First is the risk of a “repatriation trade” as global investors and portfolio managers second guess whether it is worth having most of their risk in the US when it is run by a volatile and disruptive leader. As well, if Trump’s approach on trade backfires and the EU and others begin to charge extraordinary taxes on “digital services” like the ones many Mag 7 companies offer, it could erode US earnings potential.  As well, the US can’t afford any major new expansion of government spending that has been driving much of the higher US economic growth rates compared to global peers lately. Europe and especially Germany, on the other hand, have been alarmed at Trump’s seeming intention to pull away from US security commitments to Europe and are set to launch a huge fiscal expansion that could see European growth rates outperforming in coming quarters.

Currency risk. Spoiler alert! As we will cover in Rule #3, the US dollar may be set for a major decline, in part driven by Trump’s intent to unwind what he views as unfair currency practices by major trade partners that leave the US uncompetitive on price. This could weigh on US equity market performance in non-USD terms, particularly for US firms that have a significant domestic focus in the US. Already this year (as of May 23), the US S&P 500 has drastically underperformed Europe’s Stoxx 600 in EUR terms, with the US index down just over 10%, while the Stoxx 500 is up 8.3%. The German DAX index is up a whopping 19% this year! For sophisticated investors, there are ways to hedge currency risks directly, by the way, though that also can bring additional risks.

What to do about it?

The first rule in investing is to not panic. As the Rule #2 states – while we can identify the “problem” that US markets are extremely richly valued and dangerously concentrated, it doesn’t mean that this has to mean US stocks will continue to underperform in the near- or even medium term. Who knows, it could well be that Trump begins to focus more on the pro-growth parts of his agenda and back off on most of the trade threats for a while, a move that boosts US markets once again, especially if the AI theme gets a second- or third wind. Nonetheless, given the relative risks to US equities we have outlined, non-US based investors might consider taking a number of steps over time to diversify from the very concentrated risks in the US equity market.

Reduce US equity market allocations. If your portfolio weights reflect the current global portfolio weights, you might consider reducing allocations to US stocks after a historic period of delivering exceptional returns for investors that has driven the US weighting of over 70% in global indices.

Within the US, consider equal-weight or other approaches. There are some novel ETFs that offer an “equal weight” exposure to the major US indices. This has the disadvantage that when some stocks are driving the majority of gains, you only get those gains within the window before the ETF rebalances to maintain equal exposure to all index components, which is quarterly for the most popular ETFs. Equal weight has underperformed the market-cap weighted index badly in recent years, it should be noted – precisely because of the incredible performance of the top companies.

Reallocate elsewhere. With valuations looking cheaper elsewhere in global markets, any reduction in US allocations might mean increasing allocations to Europe, where increased fiscal spending is coming from Germany, and to emerging markets ex-China, as a weaker US dollar could help drive better conditions for EM growth as it lowers the burden of USD-denominated debt and is generally supportive of global liquidity.

Clearly, risks abound for investors operating on a global perspective, which we can’t avoid doing in a hyper-connected world. The next phase of the market may be less about chasing what worked in the past and more about finding balance in a more volatile world. There are perhaps two scenarios from here – a multipolar world where Trump’s agenda is failing or a somewhat multipolar world dominated by two camps: one that is submitting to the US agenda to maintain access to US markets, and one that is not.

Stay tuned next week for Rule #3.

Also see: Hardy’s Macro View: Rule #1 for the Trump 2.0 market era.