Unmasking American exceptionalism

Stars, stripes, and silicon

The adage ‘Never bet against America’ appears to ring true as the US demonstrates a unique ability to navigate economic trials, while its tech giants have cemented the country’s market dominance. Much like the transformative railway boom of yesteryear, advancements in generative artificial intelligence (AI) have fortified the US’s standing in the global tech arena alongside China. The term ‘The Magnificent Seven’, borrowed from the 1960 American cowboy film, now refers to the seven tech companies that have effectively capitalised on the AI gold rush. These firms exert significant influence on the market through their size and influence, setting trends and the pace for the broader market.

The ascendence of the Mag 7 has raised fears of a new tech bubble, reminiscent of past episodes like the Nifty Fifty and the dot-com bubble. However, a comparison of today’s fundamentals and valuation multiples with those of the dot-com era suggests we are not in a bubble scenario. The Mag 7 are flush with cash, carry little debt, and unlike the dot-com bubble’s peak, today’s market sees firms like NVIDIA trading at 37x forward earnings³, with stock performance largely supported by earnings growth. Nonetheless, the question remains about whether the influence of the Mag 7 is overstated and how the fragmentation of the cohort impacts the broader US equity market.

In 2023, NVIDIA, Meta, and Tesla were among the top-performing stocks globally, while Microsoft, Alphabet, Apple, and Amazon didn’t secure a spot in the top 100⁴. By Q2 2024, only NVIDIA retained a position in the top 100⁵. This suggests a gradual expansion of investors’ horizons, extending beyond the Mag 7. John Weavers, Fund Manager, M&G North American Dividend Fund, notes: “The allure of the US as an investment market stems from a significant number of companies exhibiting high returns on capital and robust growth. Nonetheless, the relative growth rates are converging rapidly, and by year-end, they are projected to be broadly comparable. Paying a 30% premium for some of these companies may not seem justified, a sentiment beginning to reflect in market performance trends.”

So, can the US equity market sustain its attractiveness without the outsized influence of the Mag 7? The performance of the S&P 500 Equal Weight Index, which assigns equal weight to each company regardless of size, suggests it can. 

“Over extended periods, the S&P 500 performs almost identically to the S&P 500 Equal Weight Index,” Weavers elaborates. “This alignment serves as a powerful illustration of the broader theme: the attractiveness of the US investment market lies in the robust performance by most of its firms, characterised by high returns on capital and substantial growth. The Mag 7 have become distinctive primarily due to their size in the marketplace, but they are not uniquely positioned to scale and grow. This dominance is reflected by a substantial surge in capital reinvestment since 2016, resulting in an accelerated growth rate over the past decade and a superior equity market performance.”

Just as in the original film, ‘The Magnificent Seven’, where only three of the seven renowned cowboys survived the final showdown, the belief that the Mag 7 will collectively sustain market performance seems increasingly untenable. Investors must now seek out companies that will survive and prosper across all scenarios. What remains to be seen is how shifting economic fundamentals – driven by factors such as unsustainable debt levels, de-dollarisation, and the convergence between EM and DM economies – might challenge the narrative of American exceptionalism.
 

High noon for US economic hegemony

The preeminence of US equity markets has been upheld by an exceptional return on capital, fostered by open capital markets, a favourable regulatory environment, ready liquidity, substantial market size, and a culture that fosters innovation and entrepreneurship. However, American exceptionalism has been rooted in certain economic fundamentals that are now being undermined. The Congressional Budget Office’s June update paints a sobering fiscal picture: a $1.9 trillion deficit this year and a debt-to-GDP ratio soaring past 120% by 2034⁶. To put it in context, the US’s deficit, as a share of GDP, is set to grow from 5.6% this year to 6.1% in a decade⁷, dwarfing the European Union’s mandated 3% limit.

Tony Balestrieri, CIO of the Americas, affirms: “The issue lies in the magnitude of deficit spending across many Western economies. I am particularly concerned about the lack of fiscal discipline in the US. No matter who is elected in November, there is not a strong desire to bring the deficit back in line. Spending at current levels, which is typically associated with recessions, shows no signs of abating. If we fall into a recession, further increases in spending to stimulate the economy would only exacerbate the situation, leading to larger funding needs, higher interest expense outlays, and a potential crowding out effect resulting in higher-for-longer long-term rates.”

The dollar’s supremacy as the world’s reserve currency has allowed the US to maintain substantial trade and government spending deficits. However, the impending announcement of a block-chain-based payment system by the BRIC nations, coupled with the International Monetary Fund (IMF)’s report of a gradual decline in the dollar’s share of foreign reserves held by central banks⁸, suggests a growing momentum in the de-dollarisation trend.

This development could necessitate significant domestic fiscal adjustments, potentially restricting access to capital, increasing borrowing costs, and lowering stock market values. Broadly, it could precipitate a general depreciation of US financial assets, causing them to lag behind global peers.

Balestrieri tempers this view by asking: “Where can one turn to find another reserve currency? There is no viable alternative to the US dollar, which remains the dominant currency despite some diversification efforts. This trend is unlikely to change in the near term. While the US has its challenges, it is arguably better positioned than other options which face significant growth and demographic challenges. While the de-dollarisation trend may continue, it is not an immediate concern for the US.”

Altogether, while the US continues to demonstrate its resilience and adaptability through global economic downturns, it is clear that its exceptionalism is being tested. The fiscal backdrop is evolving where the conditions in the US economy and broader DMs open up a new dialogue about opportunities in EMs. 

Are emerging markets still the ‘wild west’?

EM equities have undeniably underperformed those of DMs’ since the 2008 Global Financial Crisis. This disparity has become even more pronounced in recent years, largely due to persistent concerns around heightened risk and volatility associated with EM investments. In reality, EM economies have consistently outpaced DMs in growth, and EM equity market volatility is now on par with that of DMs.

This shift is underpinned by two key developments: EM economies have made notable progress in enhancing their governance and economic frameworks, aligning more closely with those of DMs⁹. Concurrently, DMs have experienced heightened unpredictability and volatility, making their economic profiles more akin to those traditionally associated with EMs. This convergence is one signal of a profound transition in global economic dynamics, urging investors to reconsider traditional risk assessments.

The prolonged high-rate environment and the sluggish pace of rate cuts in DMs are proving unsustainable owing to substantial debt burdens. As the rate cycle reaches a turning point, we anticipate a renewed investor focus on EMs. Defined by healthier debt-to-GDP ratios and more robust fiscal balances, EM sovereigns have been in a more favourable position compared to their DM counterparts.

Historically reliant on China, EM growth is also now increasingly diversified, supported by a broader array of countries. Countries like India, Taiwan, and Mexico are emerging as new growth engines, bolstered by structural reforms, technological advancements, and post-COVID supply chain reconfigurations.

Michael Bourke, Fund Manager, M&G Global Emerging Markets Fund, maintains: “The heterogeneity within EMs isn’t new, but it’s often overlooked. When dispersion is low and correlations are high, investors miss out on diversification. Recently, increased dispersion in EMs has highlighted their variety, offering more substantial choices. This makes the asset class seem more diverse, though it always has been. The recent price discovery has simply made this heterogeneity more apparent.” 

Furthermore, secular trends such as AI, the global energy transition, and nearshoring are serving as pivotal growth catalysts for select EM countries. AI manufacturing is propelling the demand for advanced technologies, particularly in Asia, where countries like Taiwan and South Korea are deeply integrated with global tech giants. Previously dominated by materials, utilities, and banking, firms like TSMC and Samsung represent a development in EMs. From being virtually non-existent, the tech sector has more than doubled over the last two decades and now constitutes 24.34% of the MSCI EM Index¹⁰.

“American exceptionalism does not imply that all exceptional companies are American,” Bourke reminds us. “Many of these companies, like Tesla and NVIDIA, are exceptional due to their international operations. For example, TSMC has outperformed its US peer, Intel, over the past five years and has become a favourite among American tech investors, despite not being an American company.

TSMC is also being subsidised by the US government as part of efforts to build technology capacity within the US. This aligns with the idea that EMs also possess companies with remarkable qualities, despite the challenges they face.”

At the same time, the energy transition necessitates substantial investments in natural resources and renewable infrastructure, while nearshoring is rerouting supply chains and boosting domestic manufacturing capabilities. These trends are supported by accelerating urbanisation, dramatic demographic growth, and robust consumption patterns in Asian EMs¹¹. 

The outdated perception of EMs as the ‘wild west’ is gradually being replaced by a recognition of their growing stability and investment potential. Despite recent struggles, the changing economic environment and improving fundamentals of many EMs suggest a brighter future ahead. As these markets continue to advance and diversify, we believe they offer investors not only growth opportunities but also a vital means of achieving a more balanced and resilient portfolio.
 

Saddling up for change

The narrative of American exceptionalism has been reinforced by the strength of the US economy and the achievements of its equity markets, notably led by the Mag 7. Even with the fragmentation of the Mag 7, the US equity market retains its overall strength and remains attractive to investors due to potential high returns on capital and significant growth.

The debate about American exceptionalism is more so part of a greater dialogue about the evolving dynamics between DMs and EMs. This broader discussion highlights the interconnectedness of global markets and the growth potential that EMs present. In this scenario, it’s not so much a showdown between the US and EMs, but rather a consideration of the new sheriffs in town, as EMs increasingly assert (and in some cases re-assert) their influence on the global stage. As the US and other DMs contend with mounting fiscal pressures, unsustainable debt levels, and currency diversification, EMs – with their rapidly expanding economies and growing global influence – offer a promising avenue for diversification for investors.

The US has indeed performed exceptionally given the greater economic environment, in our opinion; however, its claim to exceptionalism will face growing scrutiny. As these trends unfold, it would be worthwhile for investors to consider the broader picture, recognising the potential for growth and diversification that EMs offer. The shifting paradigm underscores the importance of a diversified investment strategy, one that leverages the strengths of both DMs and EMs to navigate the complexities of a modern global economic landscape.