As The Tri Polar World Turns: American Exceptionalism At Risk

1660 words – a 5 minute read that distills 6000 words, 34 charts & tables from over 20 sources.

Its playoff football time and that means watching the match ups as coaches scheme to get their best players against their opponents worst.

There is a competition underway in the global economy as well; what we have defined as the Tri Polar World's (TPW) regional competition between Asia, Europe & the Americas in the three existential areas of AI, Climate & Defense.

The playing field is industrial policy; the schemes are driven by fiscal and monetary policy working in conjunction with public/private partnerships to win the competition.

We have detailed previously how China has already won the Climate competition, how the US responded under Pres. Biden via the CHIPS Act, IRA, etc. and how European efforts remain inadequate.

We note that this competition and the spending it drives plays an important role in underpinning our Global Long Cycle thesis of complementary global economic growth and global equity bull markets supported by the earnings channel.

We expect 2025 to be a year where tough choices will have to be made as financial markets take note of this competition and start to ascribe winners & losers.

Fiscal space and good governance are both critical to success and we note the recent emergence of bond vigilantes from Brazil to the UK, from France to the US as emblematic of this competition.

We expect the two regions with the most fiscal space, Europe, led by Germany and Asia, led by China, both with debt to GDP ratios of around 60% to leverage that space, stimulate their economies & compete for TPW leadership. See Charts 23 & 24.

This stimulus would support our non US equity positioning together with our Commodity OW. We note the recent breakout of GSG, our Commodity BM, in the face of rising UST rates and a stronger USD, as a tell for the direction of the global economy.

We expect the incoming Trump Admin to make a hash of its efforts on this front. Led by a chaos agent who has nominated unserious people to positions of power in Defense, Intelligence, Health and Law we worry American Exceptionalism is at risk. See Chart 7.

Yes, the economic team is solid and as global macro investors its cool to have one of our own as UST Treasury Sec. However, we question his 3 Arrows approach.

The US has been the only investment game in town for 15 years or more. It has become the world’s piggy bank where all the money has congregated. Its massive equity OP has led to record foreign investor inflows, record valuation premiums and an overvalued USD. US exceptionalism is fully in the price.

All the talk about reshoring, of production, of jobs leads us to wonder if reshoring of capital is next. We anticipate other Govts will start to encourage their capital to come home, to bring back what the Chinese call “foster money” in order to help fund their AI, Climate & Defense efforts.

Japan could take the lead here; the largest foreign holder of UST with a $1T position, the BOJ is raising rates & cutting back its ownership of JGBs just as PM Ishida contemplates further stimulus to rebuild his popularity. See Chart 11.

The US faces intensifying TPW competition with supersized fiscal & current account deficits leaving it dependent on foreign buyers of UST. Yet it has the hubris to nominate unqualified people to positions of power with an overvalued dollar, record foreign ownership and record relative equity valuations. What could go wrong? See Chart 33.

We remain positioned for non US equity OP and expect double digit non US equity returns to overshadow single digit US equity returns. We remain deeply UW FI and prefer corporate credit,  we remain OW Commodities. We would be buyers on tariff related weakens in EM given our expectation that much is in the price.

Signposts we are watching include: DXY breakout or breakdown; Commodity break out to sustain, a China led EM equity breakout, UST rates peak and China Govt bond rally reverse to signal policy traction.

CLIMATE

The gap between the incoming Trump Admin view of Climate change (a hoax) and the hills above LA on fire for days on end help one understand how China has come to dominate the entire Climate space.

While Trump prepares to take the US backwards China is moving forward, rationalizing its renewables space and improving its local Govt funding and execution process. Watch out for the Hefei model.

ECONOMICS

We remain in a global growth uptrend underpinned by the robust consumption of fully employed workforces in the US and Europe coupled with the global cap ex spending associated with the TPW Competition.

Inflation on a global basis has returned to earth and in the cases of Germany and China the threat of deflation is greater than inflation, providing policy room for both countries to leverage their fiscal space and boost investment in Germany and consumption in China. See Chart 18.

We disagree with the common wisdom that China is about to enter a lost decade similar to Japan and note Japan’s own emergence from deflation.

POLITICS

While US financial assets are priced for perfection we anticipate anything but from the incoming Trump team. Staffed with unqualified leaders, riven with policy disagreements, unburdened by elder statemen, legal guardrails or the need to run for re election, we believe American exceptionalism is at risk.

We might be at peak Trump vibes right now, just before he takes office. Governance comes next with a barebones Congressional majority, a 6% budget deficit and a world that is fully prepped for Trump 2.0. We think its only gets harder from here. See Chart 22.

Elsewhere, we anticipate a CDU victory in Germany’s upcoming election; victory is likely to mean an easing of the famed “debt brake” and an attempt to shock the country out of its economic stupor. We anticipate China’s upcoming NPC meetings to set the stage for additional fiscal stimulus believing that Pres. XI wanted to see what Pres. Trump’s 1st tariff moves will be before committing to more policy measures.

POLICY

The global rate cutting cycle remains intact, if perhaps more challenged by the bond vigilantes as they focus on who has the most fiscal space and who employes it best to win the TPW competition. See Chart 25.

The buzz around “industrial policy” is unlikely to go away as the needs in AI, Climate and Defense are too great & the skills requires too specific for it to be business as usual.

Foreign policy is likely to impact markets in 20205. Will there be peace in Ukraine – if so will its reconstruction be a boon to European growth? What happens if Russian sanctions are eased to bring Vlad to the table – will oil prices plummet? Is peace in Europe bullish for the Euro, for German rates, for the USD?

The US leads the tariff discussion but trails in the industrial policy space. We expect the Trump team to heed voter displeasure with inflation and limit its appetite for tax cuts, deportations and tariffs.

We believe it would be dangerous for the Admin to assume US fiscal space and foreign demand for UST are unlimited.

MARKETS

It’s all about earnings for equities. Our global growth outlook suggests continued global earnings growth and hence support for global equity & credit.

US equity valuations are full but valuations elsewhere are attractive. With EM EPS forecast to beat DM we remain OW global equities with a focus on non US and a lean to EM. See Chart 29.

We anticipate year three of bull market type US equity returns ( single digit) and double digit returns elsewhere. We remain OW China and look for a reversal of its recent bond rally to support equity appreciation.

Our FI UW remains intact as does our zero weight in sovereign debt within our Global Multi Asset (GMA) model. We remain focused on US and EM corporate credit.

We continue with our Commodity OW and note its strong breakout in recent weeks as seen in our GMA position leaders YTD. See Chart 13.

Our GMA and TPW 20 thematic model continue to both hold Crypto and fintech exposure; we see the broad financial space from XLF to ARKF as the cleanest Trump trade.

We remain singularly focused on the USD. Its recent rally leaves it full of crowded longs, overbought and expensive across virtually all bilateral pairs. Common wisdom holds that tariffs are USD bullish – we are not so sure and note virtually any USD policy can be found having been espoused by Trump team members in the recent past. 

We expect the vast gulf between premium US financial asset pricing and MAGA’s anti exceptionalism to be exposed in the coming years. Yet we know the trends of USD strength and equity OP are well entrenched and timing in these matters is a bitch.

Not to mix our sports metaphors but we want to skate to where the puck is going not where it is. We tend to be early but like the risk reward set up and expect the non US markets to be catalyzed by both Trumpian chaos  as well as domestic revival in Germany, China, Japan and elsewhere.

We believe much tariff risk etc. has been priced in and note the very muted response of China tech names to recent US sanctions as an indicator of this. As such we would be buyers on any significant tariff related weakness believing the gap between announcement and implementation is likely to be large. See Chart 34.

We sense we are near a trend change that is likely to last years and will restore some much needed balance to global FX and equity markets.

Our negative scenario remains some sort of US policy meltdown leading to higher US rates and inflation which limits the Fed’s ability to cut rates leading to a weaker economy and depressed earnings growth and thus a deeper US equity correction.