Wall Street has long been seen as the go-to destination for global investors to park their dollars.
This year’s rally was no exception with U.S. stocks outperforming their global counterparts by a staggering 22%, according to JPMorgan estimates in a recent note.
Some experts, however, warn that trillions of foreign dollars flowing into the likes of the S&P 500, Dow, and Nasdaq are inflating a bubble unlike anything seen in modern history.
This overconcentration, they say, has turned global investing into a “zero-sum” game dominated by a single market with severe valuation risks.
When “American exceptionalism” goes too far
The idea of “American exceptionalism” isn’t just a geopolitical term; it’s also a prevailing narrative in global financial markets.
Investors flock to the U.S. believing in its unique combination of economic dominance, investment diversity, world-leading corporations, and a central bank capable of printing the reserve currency.
This faith in the U.S. market is reflected in foreign holdings.
According to the Treasury Department, as of mid-2023, foreign investors held $13.7 trillion in U.S. stocks—a number likely much higher following 2024’s bull market.
Combined with their Treasury holdings, their total exposure to the U.S. financial system reached $26.8 trillion.
Investment heavyweights such as BlackRock and UBS actively promote this narrative. BlackRock’s chief investment strategist, Wei Li, predicts that U.S. dominance will drive the S&P 500 to new highs in 2025.
UBS strategists Evan Brown and Meena Bassily echo this sentiment, attributing expected gains to President-elect Donald Trump’s “America First” policies.
Yet, even at today’s levels, the U.S. financial system is extraordinarily overvalued compared to the rest of the world.
Fund manager Ruchir Sharma of Rockefeller Capital Management called it “the mother of all bubbles,” noting that U.S. equities are priced at record-high premiums against their global peers, driven in part by the strongest dollar in 50 years.
“Relative prices are the highest since data began over a century ago and relative valuations are at a peak since data began half a century ago,” said Sharma, who compared U.S. equities to their global counterparts.
Sharma explained that, despite being only 27% of the world economy, the U.S. accounts for 70% of the global stock market.
Concentration risks loom
This U.S.-centric investment strategy comes with significant risks.
U.S. stocks have outperformed the rest of the world by more than four to one since 2009, pulling money away from other regions, according to Martin Pelletier, senior portfolio manager at TriVest Wealth.
Portfolio managers in Asia and Europe, he notes, often invest in U.S. stocks to avoid “career risk” but at the expense of “concentration risk.”
Historically, following the herd “has worked out very well, unless you bought at the tops in 2008, 2019, or 2021,” said Pelletier. “I just worry that 2024 will be added to the list.”
David Hunter, a contrarian strategist, warns of an eventual “deflationary bust,” predicting a worst-case scenario where the S&P 500 could plummet 65% to 80%.
Such a downturn could end the secular bull market, ushering in an era of sluggish growth, high inflation, and diminished returns.
Seeking alternatives beyond U.S. borders
If U.S. stocks tumble, foreign investors are likely to seek safer havens elsewhere.
Peter Schiff, CEO of Euro Pacific Asset Management, advises investors to divest from “overpriced” U.S. equities and bonds due to unsustainable levels of federal and corporate debt.
Instead, Schiff recommends reallocating some of the portfolio to European and Asian markets, where, according to him, valuations are more reasonable.
In his view, emerging markets, particularly China, may also offer opportunities, as they begin to recover after years of underperformance. “Emerging markets are finally waking up after being beaten down all year, especially China,” said Schiff.