by Kenneth J. Entenmann, CFA®
5/20/2025, 3:07:02 PM
For the bulk of this century, it has been said that America was exceptional. It had the world’s strongest military. It had the world’s largest and richest economy. It had the world’s reserve currency. It had the world’s largest, safest, and most liquid financial markets. Most of the world’s largest and most innovative companies were American. The United States was a juggernaut. American Exceptionalism!
Yet, somehow, in just a few months, there are rumblings of the end of American Exceptionalism. Prominent financiers speak of damage to the “American brand.” The “Magnificent Seven” tech sector received a wake-up call when the Chinese Deepseek AI model was announced, which showed that the path to AI dominance would be competitive. And finally, Moody’s became the last of the major bond rating agencies to downgrade the last U.S. Treasury bond rating from AAA to AA.
Is this the beginning of the end of American exceptionalism? To paraphrase Mark Twain, the report of the demise of American exceptionalism is an exaggeration.
Apparently, several prominent financiers believe that the American brand has been damaged. Perhaps. They say our “Friends and Allies” can no longer trust the U.S. regarding military and trade. Certainly, the method of the Trump Administration’s demands for increased NATO military spending can be questioned. But the fact remains that many of our NATO “friends” are still significantly below the NATO minimum spending requirements, and even those who have committed to increased spending will not get there for several years. Given our fiscal challenges, the U.S. simply cannot afford to fund all of NATO. If calling for the end of our allies’ defense-free-riding ways is damaging to the U.S. brand, then so be it. Similarly, the rollout of the Trump trade program has been chaotic and has created great uncertainty. Our friends and allies are upset. That is understandable. But it is also very clear that these friends and allies are not free traders. They deploy a myriad of tariffs and non-tariff barriers to trade, such as a digital service tax on the U.S. tech sector, which are blatantly unfair. If calling this out is damaging our “brand,” then so be it. Regardless of the perception of the brand, the U.S. economy will remain the largest and richest consumer market in the world. Every country in the world still wants and needs to do business here. That is why there are so many ongoing trade negotiations. The hope is they will end with a freer and fairer trade environment with our Western allies.
As discussed in previous blogs over the last 12 months, we urged investors to “manage their expectations” for the U.S. equity markets. We were concerned that the U.S. equity markets were highly concentrated and highly valued. Indeed, the very idea of American exceptionalism in the U.S. equity markets drove these high valuations. After all, the U.S. equity market returns dwarfed the rest of the world since 2010. That outperformance was driven by the AI-fueled dominance of the U.S. tech sector. The “Magnificent Seven” mega tech stocks were the world’s envy. In addition, the U.S. Treasury bond market was perceived as a safe haven. The entire world was overweight U.S. growth stocks and U.S. Treasury bonds. When Deepseek was announced in January, U.S. tech dominance was questioned. At a minimum, the valuation of the Mag 7 was tested. The onslaught of the trade wars, combined with uncertain U.S. fiscal policy put pressure on the U.S. Treasury market. These factors all led to a great, worldwide rebalancing of investment portfolios. U.S. growth stocks led the decline in the equity markets, and U.S. Treasury bond yields spiked. It was a painful correction to an imbalanced world. But is it the end of the exceptional U.S. financial markets? Allocations to the U.S. markets may decline. On the margin, that suggests lower P/Es for stocks and higher interest rates for bonds. Capital may pursue some more reasonable valued equity investments and alternative bond markets. International equity markets have performed well year-to-date. Other bond markets have performed well, too. However, the U.S. equity markets remain home to the most innovative companies in the world. The valuation of the S&P 500 has declined, with the Price/Earnings ratio declining from 23 times earnings to a more reasonable and closer to the historically average P/E of 18 The difficult correction has wrenched most of the overvaluation out of the U.S. markets. The U.S. financial markets will remain the largest, best-regulated, and most liquid in the world. They will remain exceptional!
On Monday, Moody’s became the last of the major bond rating agencies to downgrade the last U.S. Treasury bond rating from AAA to AA. S&P downgraded in 2011. Fitch downgraded in 2023. What took them so long? Every politician, Wall Street strategist, and even Fed Chair Powell routinely state that the current debt level is “unsustainable.” Moody’s has finally gotten around to a downgrade, citing chronic budget deficits and rising interest rates. For long-time readers of this blog, they know this has been a frequent rant of mine. The catalyst of the downgrade seems to be the ongoing budget discussions in Washington. Admittedly, I also have been disappointed in the budget discussions. The focus seems to be on the extension of the 2017 Tax program and its impact on the deficit. The program’s extension would keep tax levels roughly the same, yet government accounting means that it would increase the deficit by roughly $4 trillion. Thus, the newfound concern for budget deficits. Apparently, the blowout spending of the first Trump and Biden administrations wasn’t a concern? Alternatively, failure to extend the tax program would result in a $4 trillion tax increase on an economy facing tariff uncertainty. Damned if you do, damned if you don’t. Either way, the current budget bill does not seem to be making much progress on healing the fiscal status of the U.S. government. But as previously discussed, Washington has a spending problem. Revenue as a % of GDP has averaged 18% over numerous tax policy regimens. Today, revenue is near record levels and hovers near the historic 18%. On the other hand, spending continues to grow, driven mainly by entitlement spending and interest rate expense. It is currently nearly 24% of GDP, unprecedented for a non-recessionary or non-war economy. The deficit was 6.4% of GDP last year and is projected to exceed $2 trillion this year. Houston, we have a spending problem! Unfortunately, neither party has demonstrated any interest in reducing spending. Witness the current debate over Medicaid spending. A proposal to require work requirements for able-bodied individuals or to charge them $100/month is met with outrage. This is “gutting” Medicaid! This morning, President Trump suggested that the entitlements are off-limits. Unfortunately, that is where the growth in spending is, and it is the largest line item in the Federal budget. This is fiscal irresponsibility. While Moody’s is late to the game, the Washington’s downgrade is well deserved. So, does the downgrade of U.S. debt mark the end of exceptionalism? The answer is yes, or mostly yes! But what does that mean? The reality is that there is a small list of AAA-rated countries. However, these countries’ bond markets have very small market capitalizations. Is it possible, on the margin, to find safety in Switzerland? Sure, their bond market is roughly $1 billion. Hardly suitable for the size of investments that sovereign nations and large institutional investors require. So, despite the downgrade, the U.S. Treasury bond market will remain the largest and most liquid in the world. Great! But it implies that, on the margin, U.S. interest rates will be higher. That is not a good thing for a U.S. economy that is already facing some challenges. At a minimum, it is a dent in American Exceptionalism.
Will American Exceptionalism remain? For the most part. Despite global military conflicts, trade war uncertainty, and fiscal challenges, the U.S. economy will remain exceptional in the long term. Our economy will remain the largest and richest consumer market in the world. It will remain the home to the world’s greatest companies. And our financial markets will remain the largest, best-regulated, and most liquid in the world. I would call that exceptional!