American Supremacy, Or Crescendo?

Michael Grant

Summary Points:

• US financial supremacy has become so mature and widely recognized that investors should be reluctant to project its extension through this decade. Equally, one should be wary of hasty assumptions about Trump 2.0.
• The risk of market setbacks is sufficiently high that clients should adopt the assumption of zero returns for the S&P500 benchmark. In other words, we think modest but secure returns in 2025 will be judged in retrospect as “good returns.”
• Market behavior in Q1 will corroborate—or not—our interpretation of today’s landscape. If upward momentum in equities does not reemerge by February, investor interest will return to more defensive assets.

As 2024 comes to a close, the most characteristic feature of the investment world can be captured by the expression “American Supremacy.” In the obvious sense, this refers to an exceptionally rewarding year for the S&P 500 Index. In another, it refers to the amplification of the predominant trend of the last decade—the stunning outperformance of the largest and most dominant US technology franchises.

It is easy to imagine that the second coming of Trump will amplify today’s extraordinary premium for US risk assets. The conundrum is that American supremacy in financial markets is already overwhelming, having predominated over an entire decade. This phenomenon is hardly accidental. It has been accompanied by some of the highest levels of corporate profitability ever recorded, boosted by fiscal expansionism.

Does 2024 foretell a new wave of the future? Yet, how can this be true for a trend already so mature and acknowledged? Ironically, it is only now that the investment community is taking seriously the implications of the slogan “Make America Great Again.” The reality is that America’s financial supremacy has become massive because it has been so prolonged.¹

2025: Expect Turbulence

The consensus view of the investment year ahead is rarely more than the cautious extrapolation of current trends. For this reason, the typical forecast for 2025 is positive but moderately so and implies investors can expect 10%–15% returns for the S&P 500. In our view, there are substantial reasons to ignore conventional thinking of this kind.

The first is what we have described² as the “invincibility syndrome.” This is our description for the unusually high US equity valuations of 2024 together with similar extreme levels of investor optimism and participation in risk assets.³ This mix signals higher-than-usual investment risk and low expected long-term returns. This analysis is undisputed by the investment community.

The second reason is tactical. Reinforced by US elections, expectations for the American economy are high and to varying degrees complacent. Analysts are projecting healthy earnings growth in 2025 while the Fed is expected to reduce its policy rate by another 50–100 bps. A combination of this variety is rare, if not unique. Embedded optimism of this kind implies the “soft landing” has been discounted.

Neither of these are good starting points for equity values. The excess returns generated by US benchmarks over the last two years have been driven by substantially positive macroeconomic surprises, especially for growth but also for inflation. In light of current optimism, extending the surprises through 2025 will be difficult.

But there is another obstacle: political ambiguity. The sense of energy and ambition attached to the emerging Trump Administration is undeniable and conspicuous by its absence anywhere else in the developed world. And yet, the enigma of Trump remains. Will he prove a radical revisionist or opportunist provocateur?

Deconstructing the Invincibility Syndrome

It is rarely difficult to argue that circumstances are more favorable than in the past, especially with respect to corporate profitability. For this reason, valuation concerns should be combined with considerations of investor sentiment and positioning. The alignment of these perspectives, which was apparent in 1999–2000, have come together again today.

The diagnosis of strikingly high equity valuations is not disputed. The debate is whether this implies a market crescendo—the forecast that a major summit for equity values is necessarily close. The primary objection to this view is that the statistical precedents are too few to situate with any confidence what this deviation of valuation from the trend implies for 2025.

Forecasting the Market Is Complex, But Doing the Math Is Simple

Source: Macrobond. Past performance is no guarantee of future results.

The common riposte for the extremes in sentiment and positioning is that speculative excess is not actually widespread—it is simply concentrated in the major US benchmarks. For every segment where speculation seems rampant, such as the AI narrative or crypto, a zone of investment neglect can be identified—Chinese equities, regional banks or energy.

Moreover, credit markets seem unperturbed: there is no message of impending stress here. The optimists argue that the equity bull can be sustained to the extent that it broadens in nature, supported by sustained growth. While the excess of concentrated US positioning is clear, some broadening of investor participation to other sectors could offset these risks, at least in the absence of a recession.

This picture is one where the investment risk in 2025 is not of the dramatic variety. More benignly, this might be a summit of the 2000 kind, without a recession and unfolding over a prolonged period. For this reason, it can be more difficult to identify market tops, which can exhibit multiple peaks over multiple quarters in contrast with market troughs.

The investment industry will always keep dancing until the music stops. Today’s setting encourages this, though a more severe outcome should not be excluded. There are some signs that recession is finally approaching, though these are not decisive, and investors have assumed that fiscal and monetary policy will backstop the most deleterious outcomes.

The Trump Enigma

Investment flows suggest that most non-US investors have come to believe that few assets can compete with the established growth stocks of America. In this respect, Trump’s electoral victory is the cherry on the sundae. The counterpart to this feast is the comparative famine of most value assets in the rest of the world.

Of course, the major regions outside America have rarely seemed so unappealing. The economic stagnation and crisis of governance in Europe is more and more apparent. The loss of confidence in China appears to be irremediable, thanks to the CCP’s inability to call itself into question. Japan's demographic decline prevents it from recovering a status as an autonomous foyer of growth.

This global supremacy of the US has coincided with the latter's growing concentration of returns. Technology stocks now account for 40% of US capitalization. Since the 2008 crisis, the dominant trend across global equities has been concentration–the opposite of diversification. Global capital has been reallocated from the periphery to the American center–another form of deglobalization.

Yet, American financial supremacy has become so mature and widely recognized that clients should be reluctant to project its extension through this decade. Equally, one should be wary of hasty assumptions about the consequences of Trump 2.0.

The Trump influence since 2016 has already significantly contributed to America’s financial supremacy. The transition to fiscal expansionism has been an enormous tailwind for economic growth and spurred the rise in corporate profitability. Trump would like to extend that through lower taxes, lower interest rates, business-friendly regulation and low energy costs. Yet, there are major obstacles.

The Federal deficit has risen to over 6% of GDP, while interest expenses as a share of federal receipts⁴ are ballooning. Can fiscal expansion be extended without destabilizing the bond market? Without a degree of fiscal restraint, is an agenda of domestic growth that does not rely upon an improved labor supply or imports from low-cost sources compatible with price stability?

To assume that a productivity miracle can reconcile much of this is hopeful thinking. Even Trump skeptics can see the difficulty of maintaining the benign trade-off between growth and prices. The persistence of inflation in service sectors is one clear warning. Another is that long-term rates have failed to proceed to new lows—unlike prior soft landings of the past four decades.

Will the Bond Market Say “No”?

A soft landing for the US economy, policy support from the new administration, and good news from corporate America are confidently expected by many. Yet, when everybody is bullish and positioned accordingly, the upside for financial prices is confronted by “natural law.”⁵ In a benign outcome, or one notable for the absence of negative shocks, 2025 could be a year of consolidation for equities.

Two kinds of conclusions emerge from this. First, risk is skewed to the downside because so much favorable news has been discounted. The second is that the upside potential should be tedious considering the current scale of the commitment of investment capital to the leading segments of the US bull market.

We think the risk of setbacks is sufficiently high that clients should adopt the assumption of zero returns for the S&P 500 benchmark. In other words, we think modest but secure returns in 2025 will be judged in retrospect as “good returns.” Market behavior in Q1 will provide strong indications about the nature of the year ahead and thus the corroboration for this forecast.

We expect the current post-electoral wave of equity advance to climax no later than the end of January. By the Inauguration, the various post-election trades should be exhausted. Equally, the hyperscaler releases at the end of January will benchmark sentiment for the stunning capital spending plans that underpin the AI narrative. We view the latter as ripe for disappointment.

One response to anxiety about America's growth leadership is to rotate into value stocks and value markets outside the US. However, all equity markets today are correlated to that of the S&P 500, to a greater or lesser degree. The primary exception among major markets is that of China, which now operates on a different strategic plane and should be off limits to risk-averse Western investors.

The key will be whether upward momentum in equities can reemerge by late February. If not, interest will return to more defensive assets, including value with safe-haven qualities. We are not assuming a deflationary shock. In our new world of policy intervention and fiscal expansion, the problem is likely the inability to re-establish price stability durably in a context of mediocre growth.

The neutral Fed funds rate should not fall below 2.5%–3.0%. Accordingly, the steepening of the yield curve should prevent the yield of the benchmark 10-year US Treasury from descending below the 4% area. Naturally, there will be considerable pressure on the Fed to continue reducing rates even without evidence that price stability is secure.

This is a macroeconomic context in which the "great moderation" cannot return. The expression of investor anxiety, which may be most characteristic of this remaining decade, concerns government debt and fiscal sustainability. Will the tax cuts, eagerly anticipated by investors, undermine financial prices in 2025? Trump will inevitably test the bond market to further slash taxes and promote his agenda.

The US equity world is nearing a crescendo—a major summit that could take years to overcome. This is not an outlook of sudden or precipitous reversal, though it cannot be excluded. More plausible is a market summit of the year 2000 kind, unfolding over many months and quarters and characterized by tedious consolidation rather than collapse. The warning signs are multiplying.

¹The terms of trade for the US economy and the value of the US dollar have been on a rising trend since 2011. As a consequence, the weight of US equities in the market cap of the MSCI All Country World Index has risen from 43% in 2010 to 65% today.
²See Q3 Quarterly Commentary.
³Flow of funds data indicates that the allocation to equity of US households as a percentage of their total financial assets has risen to its highest level on record, at nearly 35%. NAAIM data confirms that retail and professional investors have raised equity exposure to the upper levels on record. Cash as a percentage of assets in equity mutual funds has fallen to record low levels.
⁴Interest expense as a share of the Federal budget has risen from less than 3% in 2016 to 17% today, on its way to an estimated 26% in 2027.
⁵Who is left to push financial assets higher if everyone is already fully invested?