Back in December, I wrote a piece expressing concerns about the ubiquity and strength of the “US exceptionalism” narrative. A heady mix of overconfidence in our ability to predict an always-uncertain world, stellar past performance, and expensive valuations is always a reason to worry. At the time, the overwhelming consensus was that the US economy and stock market could only ever outperform others. Writing that piece felt a little heretical. Four months later, it feels uncontroversial. Why did everything change so quickly — and what does it mean for investors?

We Ignore Risks Until We Feel Them and See Them

The problem with the US exceptionalism argument was not that it was without any merit, but that investors became wildly overconfident that it was undoubtedly true. That belief — reflected in extreme valuations and returns — became far too strong. US outperformance wasn’t seen as merely likely; it was inevitable.

When something persists for a long time — such as the dominance of US assets — it becomes difficult (perhaps impossible) to imagine any other outcome. What has changed in recent months is that investors have begun to acknowledge a broader range of possible futures. Risks to the US are now being taken seriously when previously they were ignored.

The World Is Not More Uncertain — But We Are

I’m always sceptical when investors say the world is now “more uncertain.” Was it really more certain before it became uncertain? What people mean is that they are now assigning meaningful probabilities to a wider array of plausible scenarios. The future is not more uncertain — we are just being more realistic about it. 

Overconfidence and Complacency Create Fragility

Why has sentiment changed so quickly? Because when investors are complacent about risks and overconfident about the future it creates fragile systems. When we behave as if one outcome is certain, we are — by definition — unprepared for anything else. We cannot be resilient to scenarios we have entirely discounted.

Most Major Investment Errors Involve Mistaking the Cyclical for the Secular

One of the most consequential mistakes investors make is treating cyclical phenomena as if they are permanent. The peak of any asset performance cycle usually coincides with vehement arguments that the trend is not temporary. High valuations and significant capital flows at these moments reflect the belief that nothing will change. The longer the upswing lasts, the stronger the secular argument becomes.

Incentives Drag Us Away from Sensible Investment Disciplines

A substantial portion of the inflow into US assets over the past decade has come from investors making prudent decisions to hold meaningful exposure to the world’s largest economy and stock market. However, another significant portion was driven by performance-chasing. The pain — and perceived risk— of poor relative returns from holding non-US assets forced many investors’ hands.

For non-US investors, allocating to US assets made sense when they were performing well. What they are now realising is that ‘improved global diversification’ can easily morph into concentrated exposure to a single country when sentiment turns.

Non-US Investors Had It Too Good

Non-US investors who adopted a global approach have enjoyed remarkable returns — exposure not only to a dominant stock market but also to a strong US dollar, which has also acted as a safe haven during market stress. That’s an ideal combination. But it’s also an extraordinary one — and not something we should expect to continue indefinitely.

We shouldn’t doubt this dynamic persisting because we can predict the future, but because betting that it will continue is inherently risky. Investors are used to pricing in the political risks of China or the stagnation in Europe. But many hadn’t considered the possibility of a world where US equities and the dollar are weak simultaneously — simply because it hasn’t happened for so long. They should consider it now — not because it will happen, but because it could.

Nobody Knows What Happens Next

Most people were wrong about the inviolable nature of US exceptionalism and wrong about the consequences of Trump’s election victory, so don’t listen to anyone who claims to know what comes next. The speed with which we’ve shifted from “ongoing US dominance” to the “decline of the US empire” tells us all we need to know about market predictions — and those who make them.

What Should Investors Do?

There’s a real danger that investors overreact to the current market environment. The shock of risks materialising — risks they had previously ignored — may tempt them into drastic shifts in their investment approach. That would likely be a mistake. Swinging from “no risk in US assets” to US assets becoming “exceptionally high risk” is unlikely to produce rational decisions. The truth lies somewhere in-between.

Investors should use this relatively limited reversal in US performance as a moment to reflect: Has the extraordinary performance of US assets made them complacent about risks they now feel significantly exposed to?

The Critical Question for Investors

Many investors will now devote time to forecasting the effects of shifting political and economic dynamics on US assets. This is the wrong approach. It’s always difficult, but right now it’s impossible. We must resist this temptation or face making a succession of inescapably poor choices.

Instead, investors should be asking this:

Have I made long-term, structural investment decisions that were overly influenced by a prolonged period of US outperformance — leaving me vulnerable to a changing environment?

This might apply to non-US investors who’ve gone all-in on US assets, assuming the past fifteen years will repeat forever. Or US-based investors who see international diversification as pointless because “the US always outperforms”. In other words:

Have portfolios been optimised based on an unusually favourable, possibly unrepeatable, environment for US assets?

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All that’s really happened in recent months is a return to realism: a reminder that the future is uncertain, and even long-standing trends can reverse in a heartbeat. Sentiment and valuations at the end of 2024 seemed to lose sight of these truths. 

I have little idea what happens next. Maybe the US resumes its dominance. Maybe it enters a decade-long spell in the doldrums. Whatever the outcome, recent performance should prompt all investors to reassess risks that — if we’re being honest — many had stopped thinking about.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).