Geopolitics, US Exceptionalism and Asset Allocation

Hello this is Inigo Fraser-Jenkins from Alliance Bernstein.

Recent months have seen an upending of the economic and geopolitical system. Unsurprisingly, this has dominated conversations with clients in recent meetings around Asia and Europe. The investment community has understandably focused on tariffs, as that dominates the near-term outlook. In our recent research, though, we have tried to draw the attention to the deeper shifts that have taken place.

The biggest change in recent months has been the rapid geopolitical re-alignment, with the future of NATO and other multilateral institutions now in doubt. This leads to the question of trust.  To what extent has trust in the US evaporated?  Does the case for US exceptionalism still stand? What does this mean for allocations to US assets? In our research we have discussed how the issues of debt, the dollar and defence policy are inter-linked.

Fiscal sustainability has long been a worry, not just for the US but for the G7 overall. This has become a more immediate question for investors in the face of lower growth and a deteriorating fiscal position. However, there is no level of debt/GDP which constitutes a hard limit. Afterall, Japan exceeded the current US level of debt a long time ago. In our note we discuss the so-called Ferguson limit. This compares the interest cost of debt to the defence budget. In 2024, the US service cost of debt exceeded the defence budget for the first time. A recent paper by Niall Ferguson suggests that when this has happened to great powers in the past it threatens their ability to retain that status. He cites unhappy comparisons to Hapsburg Spain, Austria-Hungary, the Ottoman Empire and the UK. When this happened to the UK in the 1920s, the way to retain hard power was devaluation and the loss of sterling’s reserve currency status. It is awareness of this that could be a driver of current US policy.

The new consensus that is emerging is that the US has lost its exceptional status and investors have been reallocating capital elsewhere as a result. It is true that the near-term outlook for the US has rapidly deteriorated. Our model for US earnings growth has plunged, and now is consistent with a 50:50 chance of an earnings recession. Moreover, the risks to this are on the downside given the rapid fall in capex intentions.

Given the unanimity of consensus to overweight the US at the beginning of the year, there are presumably more short term flows to come out of US equities. However, exceptionalism is a strategic concept and not a tactical one. We think that US exceptionalism still stands, driven by fundamental forces like a growing working age population, in contrast to Europe or China. It also retains advantages of high levels of corporate profitability, scale of home market and security of energy supply. So despite near term outflows to come, we still retain a strategic overweight in US equities.

The other key question for global investors is the role of the US-dollar. Whether or not a mooted Mar-a-Lago accord comes to pass or not, we think that the defensive nature of the dollar has changed, and is related to this fundamental question of trust. Thus we do think there is a case for global investors to hedge more of their dollar exposure.

In a radically more uncertain world, the knee-jerk reaction may be to de-risk. However, this raises questions of what is a defensive asset if the role of US bonds is questioned? Moreover, with an outlook of strategically higher inflation made more likely by recent changes, investors who need to earn a positive real return may not be able to afford to de-risk. Our strategic asset allocation with an overweight allocation to real assets and equities along with positions in private assets and gold reflects this.

Thank you for your time.