Speaking at a National Republican Congressional Committee (NRCC) dinner on April 8, President Donald Trump didn’t hold back in defending his aggressive tariff policy. Trump proudly mocked foreign leaders by saying, “These countries are calling us up, kissing my a**. They are dying to make a deal.”
Classic Trump bravado.
Even if you’re a MAGA die-hard, it’s important to recognize that many living overseas aren’t happy with President Trump. Global sentiment toward America appears to be shifting. Read a few opinion columns in international publications and you’ll see what I mean.
In January net purchases of US equities by foreign central banks plummeted $28 billion. This was a rather dramatic change in trend, as shown below.
It’s interesting and at least slightly disturbing to see that foreign capital was aggressively fleeing the US in January. Keep in mind, that was before President Trump humiliated President Zelensky in front of the world, and before Trump unveiled his thorny tariff numbers in the Rose Garden.
President Trump is following through on his campaign promises to create a more isolationist America. An unintended consequence could be a broad repatriation of capital from the US to the rest of the world, and that’s an investment risk most investors aren’t adequately positioned for.
Unpacking The Global Leadership Cycle
No single country outperforms forever. The US has beat the rest of the world’s stock markets for a very long time, and this year is likely to be a turning point.
The magnitude of US equity outperformance has been staggering since 2010. Whenever mean reversion occurs, it could be a long way down.
Valuations are an expression of investor sentiment. It would be easy for foreign investors to justify selling US assets on a valuation basis, because US assets trade at a hefty premium. For example, the S&P 500 trades at a forward P/E ratio of 20, which dwarfs Europe’s STOXX 600 at 13, and Brazil’s Bovespa at 7.
Comparing individual stocks sometimes helps clarify a fundamental disparity.
Siemens (SIEGY), a German industrial giant, is one company that stands to benefit from the shifting tides. Siemens competes in growing markets driven by digitalization and the energy transition, while its industrial equipment generates steady aftermarket revenue. Siemens offers investors better value and growth prospects than many S&P 500 firms. For example, why buy Honeywell at 19 times earnings when you can buy Siemens at 15? Siemens is expected to grow earnings 18% this year compared to only 7% EPS growth for Honeywell.
Other investors may want to rotate money from the US to a country like Brazil. Brazil is rich in natural resources and has positive demographic tailwinds. Itau Unibanco (ITUB), a high-quality Brazilian bank, is expected to grow earnings 11% this year. Why not sell a US bank like JPMorgan, which is expected to see its net earnings fall 9% this year, and buy a stock like Itau that has superior growth potential? Itau trades at 1.6 times book value compared to 2 times book for JPMorgan.
The spark for a durable leadership rotation at the macro level is usually a mix of attractive valuations and a fundamental catalyst that reverses sentiment. Flows follow.
Interestingly, global leadership inflections tend to occur during bear markets. The MSCI World Index, which includes both the US and foreign developed markets, experienced declines exceeding 20% in key years when global leadership cycles reversed, i.e. 1990, 2002 and 2008.
The MSCI World fell almost 17% between February 19 and April 8. It could easily exceed the 20% drawdown threshold to qualify as a bear market later this year. Earnings expectations are still too high and that may be the next shoe to drop. Is 2025 going to be the next big shift in global capital flows?
Passive Investors Risk Being Late to Rotate
Passive investing works fine when the world isn’t changing much. The problem for passive investors is this is one of those rare times when the world is dramatically changing.
If international equities continue outperforming like they have been year-to-date, passive investors will be caught dramatically offsides. For instance, consider a typical 55-year-old Vanguard client’s target date fund, like the Vanguard Target Retirement 2035 Fund. Per Vanguard’s allocation models, it might hold:
- 50-55% in US stocks
- 25-30% in foreign stocks
- 10-15% in US bonds
- 5-7% in foreign bonds
Point is: passive portfolios are heavily weighted to the US.
The passive investing style is mind numbingly simple. It’s a strategy that systematically invests in the biggest winners from the past (i.e. the biggest market cap stocks). Some of the largest US companies have bigger market caps than entire European countries. The gap has grown so wide between the US and international markets, it will take a very long time for passive index funds to catch up to the trade if international stocks take over the leadership baton.
Bottom-line: President Trump’s tariff-driven bravado, while rallying his base, risks igniting a seismic shift in global capital flows that investors cannot afford to ignore. Make sure you don’t get caught flat footed.
Disclosure: I own shares of Siemens and Itau Unibanco in client accounts I professionally manage.
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