00:00Is it still the end of exceptionalism theme that is intact or where are we in that debate?
00:05Yeah, thanks Yvonne and thanks for having me on again today.
00:08You're right, the end of exceptionalism is the big story that investors want to talk about.
00:13I think it's probably helpful to break down the jargon a little bit
00:17because when people say end of exceptionalism, it's often not that well defined.
00:22So I like to think about it in terms of exceptional GDP, exceptional stocks and then the exceptional dollar.
00:27And each of those has been a really important aspect of the story for global investors over the last decade or so.
00:33And the problem is that the cracks are starting to show in each of those elements.
00:37So if we think about the GDP story, the big boost to GDP has been around the fiscal support, immigration,
00:43both of which are checked now to greater or lesser extents.
00:49The stock market story has been about the supernormal profits, mega cap tech, the MAG7 after the deep seek moment,
00:56big question marks there.
00:57Still, we see U.S. equities with premium valuations, which doesn't bode well for future returns.
01:04And other global stock markets are offering as good earnings profile over the next 12, 18 months as we see in the U.S. now.
01:11So a big change on the stock market outlook.
01:14And like you mentioned, the dollar has been behaving in a very strange way.
01:19Many global investors very confused at the way the dollar is behaving.
01:23Stocks selling off, bonds selling off and the dollar selling off.
01:25There's a sort of an emerging market theme there.
01:29It doesn't look like what we're typically used to seeing.
01:31The dollar is the safe haven story.
01:33So the combination of the dollar still being two standard deviations expensive versus most global currencies
01:38and the macro vibes looking a lot more negative than what we've gotten used to
01:43means that I think the cracks are starting to show in that exceptionism story on the economic side, on the stock market side and on the currency side.
01:50And so many investors want to rotate into Europe, into Asia, into other parts of emerging markets.
01:55In recent years, the Fed has served as, I guess, the kryptonite to be able to reverse maybe some of the trends.
02:04Could they be that catalyst that maybe reverses not all of that, but some of that, for example?
02:11Can I look at the Fed and say if they start cutting, some value then emerges in U.S. markets?
02:15For sure.
02:16That's the shock absorber.
02:17That's always the shock absorber.
02:19Cutting the cost of capital is the shock absorber to allow P multiples to stay elevated rather than the bad macro vibes
02:27running, having been forced to run through equity markets.
02:31But the problem is, David, that the Fed is in a bind.
02:35The implementation of policy uncertainty and tariffs gives it a stagflation light sort of situation, at least in the very near term.
02:43And that means that the Fed is reactive rather than proactive.
02:48And that's a big change for investors because we're so used to the Fed being proactive, cutting aggressively in the early phases of a slowdown.
02:57And for the last decade or even more, most central bankers have really been focused on this idea of macro stabilization,
03:08They haven't had to worry so much about the other side of the mandate.
03:12They haven't had to worry so much about the inflation piece.
03:15But a mini stagflation shock from the tariffs, that means that they're a bit more two-minded and it forces them to be reactive.
03:22So for U.S. stocks, you've then got a kind of triple problem, really.
03:26Premium valuations in terms of P's being above long-run norms.
03:30Profits outlook still, I mean, having been downgraded, but still 10% profits over the next 12 months is the analyst expectation.
03:37It still looks a little bit elevated given the bad news that we're seeing on confidence, the vibes around the economy.
03:44And there's a big question mark around the shock absorber.
03:47If the Fed is in reactive mode, if the bond market is misbehaving, as it has been doing, rising long-term bond yields,
03:54the relative valuation story doesn't free up a wriggle room or a margin of safety for stocks.
04:01So I think, again, it feeds into this idea of U.S. exceptionalism being challenged and questioned.
04:06And you can see on that basis why investors are preferring more lowly valued stock markets in Europe or in Asia
04:12with a catalyst from policy or from macro or from central banks being more proactive.
04:19It's, I think, to the point you're making, it's, you know, as large as the U.S. stock market is,
04:24it's easy to find, easier to find alternatives, right?
04:27You go to Japan, you go to Europe.
04:29But the bond market seems to be, you know, the Fed's cutting.
04:33Why are yields moving up?
04:35And, you know, the Treasury market, that's the benchmark for the global financial system.
04:39Most liquid.
04:39It's the most liquid.
04:40It's hard to replace, as Moody's called this week.
04:42And I'm wondering, you know, what are the second-order derivatives that we have to be paying attention to?
04:46Like, what does this do if yields keep pushing up in the U.S. Treasury market?
04:51Well, it's remarkable, and it's remarkably important.
04:53So you're exactly right.
04:55In some respects, the key development.
04:58So I like to joke that it's the reverse conundrum.
05:01You might remember in the early 2000s, Greenspan and then Bernanke had this idea of the conundrum on interest rates.
05:07They were hiking interest rates, what, 16, 17 mini-hikes, 25 basis points hikes from 2003 onwards.
05:15And bond yields were stable or falling at the long end of the curve.
05:20And so Greenspan famously called this the conundrum.
05:22Bernanke did a lot of research, said it's global savings, having a glut of global savings, forcing long-term bond yields to stay capped and even move lower.
05:31But if you fast forward to today, we're in a totally different environment.
05:35It's the reverse conundrum, the opposite of the conundrum.
05:37The Fed started cutting at the beginning or the end of Q3 last year, the beginning of Q4.
05:42We had those cuts responding to the weaker labor market data.
05:45So we've started the cutting cycle.
05:47And normally you would expect long-term bond yields to be at least stable or falling slightly following the beginning of the Fed cutting cycle.
05:55And instead, we've got risk premium, fiscal worries, concerns around the U.S. fiscal position really coming into the long-term bond yield and a bare steepening of the curve playing out.
06:07And it changes things materially.
06:09It changes relative valuations.
06:12It forces investors to think again about where safe assets are.
06:15And it challenges the growth story in U.S. stocks, which had already become 70% of global equity market weight.
06:24With hindsight, that looks like a top, isn't it?
06:28A topping process.
06:29So profound implications.
06:31And then really big implications for other global bond markets.
06:34You've probably seen Switzerland has moved back into negative bond yield territory.
06:38You can see these other safe havens are not as deep, not as liquid.
06:42So as capital moves to other locations, it really has an outsized move on prices, forcing yields materially lower as investors look for other safe havens, bond substitutes away from longer term treasuries.
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