US exceptionalism isn’t dead

Medium-term concerns remain on US growth and equities valuations. Any US recession would likely be global. Near term downside risks to the economy are greater in Europe and the UK.

US equities have lagged Europe and UK year-to-date for sterling investors. Is US exceptionalism dead?

US exceptionalism isn’t dead

By Mike Bell, CFA, Interim Macro Investment Strategist at Elston Consulting
 
​US stocks have underperformed Europe and the UK year to date for sterling investors. However, that has mainly been down to the weakness in the dollar. From this starting point, we’re not convinced that European and UK stocks will continue to outperform the US.

The USD dollar has weakened by around 7% this year and the Euro has risen by around 5%, both against the pound. But from here, it seems less clear that the dollar continues to depreciate against these currencies. Fiscal sustainability concerns are not unique to the US, with the UK and France arguably even more vulnerable.

While tariffs are likely to weigh on US growth, Europe is probably more vulnerable to tariffs than the US. German manufacturing, which was already struggling with competition from China and high energy costs, is seeing exports contract, according to the latest PMI business surveys. French manufacturing new export orders are also weak. The service sector saw a contraction in new orders too in September, in both France and Germany. While Italy and Spain have been holding up better, there is a risk that weakness in France and Germany, the continent’s largest two economies, spills over into the rest of the Eurozone.

The UK is struggling under the weight of the increase in employer National Insurance contributions and the rise in the minimum wage. When combined, these have led to UK labour costs rising faster than sales for many businesses. This has resulted in job cuts in cyclical sectors. Lower paid sectors such as hospitality and retail have been particularly badly affected, although job cuts are also spreading into other sectors.
The US economy also faces medium term risks from a slowing labour market. However, with strong investment in AI and business surveys that are stronger in the US, we judge that near term downside risks to the economy are greater in Europe and the UK.

The key concern is that valuations in the US already factor in a lot of good news. We do think that this could potentially pose a risk, in the medium term, to US equity returns but think that while jobless claims remain low, AI related capex remains strong and new home sales hold up, being underweight the US could be a risk in the nearer term.

With the Fed already priced to reduce rates to 3% over the next year, the ECB having already cut rates to 2% and the Bank of England only priced to cut rates to around 3.5%, there is a risk that rates could fall faster in the UK than is currently priced, which along with concerns around the UK fiscal situation as the budget approaches, could lead to Sterling weakness against the US dollar.   
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Overall, while we have medium term concerns about the global economic outlook and US equity valuations, we think any potential US recession would cause a global recession too. There is a quite plausible scenario though in which Europe and the UK experience a recession in the near term, while the US avoids one. Taking all this into account, we think that it is probably too soon to prefer other equity markets to the US.