Macro Minute: Week of March 17, 2025
There is one graphic that keeps sticking with me. This version is from Ritholtz Wealth Management.
This Macro Minute is a longer framework piece to describe how we got to where we are in capital markets and where I think we are going.
To begin with, I want to bring up the term fungibility. In open free markets, capitol will go where it is treated best. The term fungibility means that capitol can be freely exchanged for capitol of like kind. Since 2009, after the great financial crisis, this has meant that capital has flowed into the United States capital markets from abroad. This influx has been in both the stock and bond market. U.S. deficits and looser policy has benefited U.S. markets as clearly seen in the chart. The rest of the world has been much more fiscally responsible (less debt) and has had smaller stock market gains, but much of the rest of the worlds savings has made its way to U.S. capital markets.
The reason this has been possible is because the U.S. dollar is the reserve currency of the world. Mechanically, the world has been paid in their home currency and have bought U.S. assets, making these investors long both U.S. stocks and U.S. dollars (meaning that investors expect the value of US stocks and the dollar to increase). This has been a steady flow for a decade and is part of the reason for the chart above and why the U.S. dollar has been strong against other currencies. Yes, the U.S. has had better business policies and is more entrepreneurial than some parts of the world, but that does not explain the above chart. Markets are momentum chasing by nature. As parts of the U.S. market have done well, it promotes the U.S. market continuing to do well because capital flows to where it is treated best. Best in this regard means highest returning.
If, and I want to emphasize it is still an if at this point, capital is now exiting the U.S. in search of returns abroad, everything is going to get flipped on its head. I dearly hope that this stays an orderly transition. I don’t want to see a limit down futures market, a dollar that is falling straight down versus other currencies, or all markets falling together. What we have seen over the past decade is foreign buyers of U.S. assets causing futures to be green at the U.S. open. What we are seeing now, and possibly will continue to see, is futures red at the U.S. open from overnight selling.
I want to bring back something I said to clients at the end of the year, to quote The Wise Man’s Fear by Patrick Rothfuss, “There are three things all wise men fear: the sea in storm, a night with no moon, and the anger of a gentle man.” If I were to add a fourth fear it would be “crowded trades”, and it does not get much more crowded than the Mag7 these days. When I said this, I was noting how everyone, both U.S. and internationally, are holders of these seven companies. It did not matter if you are an active manager or passively buying the index, everyone owned a large slug of these companies. I am not saying anything about the quality of these businesses, only noting how heavily owned that they are. This is probably easiest to observe in what I wrote on January 27th about how much they represent in the indexes. https://longviewfa.com/macrominute_01-27-2025/.
So, what are some likely trends to see going forward? I think that we could have trends that take years to play out. This could look like the dollar being weaker than other currencies for a long while. This will make U.S. exports more attractive and potentially help the trade imbalance. If we see continued support of international markets by their governments like we have been seeing, capital will continue to flow back to those international markets from the U.S. like has been happening so far this year. There could be a very sizable appreciation of international stocks given the disparity of size relative to U.S. stocks. This does not have to be a recession in the U.S., but it could if investment and spending stall out. As an investor, remaining diversified and having meaningful allocations abroad should help preserve your portfolio. Asset managers that have overweighted U.S. growth stocks will likely scramble to get to a more balanced portfolio. If liquidity gets scarce, expect the Federal Reserve to begin providing assistance.
This is an attempt to help you understand why we are seeing the drawdown in U.S. growth stocks. This is different than 2022, when they fell primarily because of inflation and interest rate hikes. If this is a true rotation out of U.S. to the rest of the world, it will take time to unfold and presents as much opportunity as discomfort to a diversified investor.
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