�۶���Ƶ

Market narratives change fast. Entering 2025, most investors were all-in on US exceptionalism. President Trump’s tax cuts and de-regulatory agenda were expected to boost the US growth and earnings outlook, while tariffs would be disproportionately negative for the rest of the world. Investors came into the year overweight US stocks and the US dollar.

In retrospect, the consensus couldn’t have been more wrong. Trump’s decision to ‘take on the world’ in trade meant the sharpest downgrades in the growth outlook were in the US. The emergence of DeepSeek challenged assumptions of US AI dominance and bolstered Chinese equities. The threatened removal of the US defense umbrella drove Germany to generational shift in fiscal policy. These developments have all contributed to the S&P 500 underperforming the MSCI All-Country World ex US Index by 14% so far this year (including currency moves).

Indeed, there have been several days and weeks this year with the trifecta of US weakness: US stocks, bonds and the dollar all selling off at the same time. In a matter of months, the US Exceptionalism narrative has been replaced with ‘Sell America.’

Here we make three points. First, on a strategic horizon, we think there are good reasons for investors with a large US overweight to reduce exposure. The US economic outlook is somewhat less exceptional and assets a bit riskier, at a time of still high relative valuations in equities and FX. At the same time, there are limits to how much and how fast investors can or should diversify away from the US, given liquidity and structural advantages in US markets. Finally, portfolio re-allocation doesn’t happen in a straight line, and we see room for tactical outperformance in US equities. This may provide opportunities for strategic diversification into other markets over coming months, for portfolios with an already significant US overweight.

For years, relative valuations have pointed in the direction of US equity underperformance. And in the lead up to this one, investing in regional equities purely on valuations has proven to be spectacularly wrong. US economic and especially tech earnings dominance have delivered stellar returns versus the rest of the world.

But while there has long been a valuation case, we see catalysts for further mean reversion. Slowing immigration in the US will by definition reduce labor force and potential growth. Tariffs are a supply shock that will likely crimp corporate margins and raise inflation. From Germany to Canada, countries are responding to US policy shifts with increased fiscal support which should narrow growth differentials. Meanwhile, in the US tech earnings growth remains robust, but there is normalization versus global markets. While the US maintains an edge in corporate governance and innovation, it looks somewhat less exceptional in light of these recent developments.

Moreover, return correlations across regions have broken down in recent years. US tech concentration and varying country fiscal policies are at work here, among other factors. With these dynamics and broader ‘de-globalization shifts’ underway, we see good reason for regional correlations to remain lower than their historical average. This is important because even if the US were to moderately outperform, lower correlations means increasing diversification may bring down overall portfolio volatility, boosting risk-adjusted returns.

Exhibit 1: Equity return correlations across regions have broken down

Average pairwise correlation across equity regions*

*Equity regions: US, Europe, EM, Japan, Switzerland, China, Canada

Geographical diversification in fixed income makes sense to us as well. US debt dynamics are increasingly concerning, with the fiscal package moving through Congress likely to add to an already unsustainable debt situation. As mentioned above, tariffs are creating a supply shock for the US, which may increase inflation and may limit the ability for the Federal Reserve to respond to lower growth. Ex-US central banks facing only a demand shock from tariffs should have more room to ease if growth and inflation slow more than expected, potentially allowing more room for their regional bonds to rally.

On FX, less exceptional US growth should weigh on the USD. Many large ex-US institutional investors hold FX unhedged positions in US assets. �۶���Ƶ Investment Bank estimates that foreign investors hold US assets with a 20% FX hedge ratio for equities, and a 50% ratio for fixed income. The recent shift in the US equity/USD correlation from negative to positive should incentivize ex-US investors to increase hedges on the USD to reduce risk of losing on both the underlying asset and currency returns. This should put structural pressure on the overvalued USD over coming years.

At the same time, there are limitations on how quickly and by how much investors can exit US markets. The US boasts the deepest and most liquid markets in the world. In our view, the scale of US markets can absorb large transactions with less price impact than most others.

By contrast, many other countries’ markets are much smaller or less liquid – large flows out of US assets into foreign assets could quickly overwhelm certain markets. For example, the entire eurozone equity market is barely half the size of the US; emerging markets (EM) are smaller still. A pension fund or central bank attempting to shift hundreds of billions from Treasuries into, say, European or EM bonds would encounter limited supply and wider bid-ask spreads. Thus, institutions often keep an overweight to US assets simply because they can deploy huge sums there efficiently.

Additionally, the US has a long track record of strong corporate governance, financial transparency, and legal protections. This instills confidence, especially among institutional investors and fiduciaries, that large allocations to US assets carry lower operational and governance risk. Some other markets – while growing – may have corporate governance issues, political interference, or less mature market infrastructure.

However, one potential change to this perception would be the taxation of investor income – something being considered by the Trump administration and Congress. In the proposed ‘One Big Beautiful Bill Act’, Section 899 adds a new US tax code titled ‘Enforcement of Remedies Against Unfair Foreign Taxes’ which allows the US to increase withholding tax rates (by 5% a year to a maximum of 20%) to individuals and companies of countries the Treasury deems has ‘discriminatory’ taxes against the US (for example via digital services taxes). If passed, it is unclear how actively such a capability would be used (indeed, the new authorities may simply provide leverage in getting other countries to reduce taxes on US companies). But instituting a law that allows for taxing foreign asset ownership in the US could raise risk premia on those assets. This might enhance the ‘Sell America’ narrative medium term, if enacted.

As much as one might embrace the ‘Sell America’ theme medium term, it may well be stretched on a tactical basis.

Bank of America’s Global Fund Manager Survey (FMS) – a widely followed gauge of institutional sentiment – shows extreme underweighting of US equities and the dollar in recent months. In May 2025, global fund managers reported a net 38% underweight in US stocks, one of the most bearish readings in decades. This represented a near 60 percentage-point plunge in US equity allocation since January. Also in May, the FMS showed the largest underweight in the US dollar since 2006 as well, with a net 17% of participants underweight the USD – the most underweight dollar position in 19 years. Such capitulation-like positioning often serves as a contrarian indicator.

Exhibit 2: BoA Fund Managers Survey shows extreme underweighting of US equities

Net % OW US quities

On a tactical horizon (3-6 months), we think US equities can outperform for a few reasons. First is the aforementioned contrarian sentiment and positioning in US equities, which could easily rebound on improving US economic and policy developments. Second, following the Q1 earnings season, US earnings have materially outpaced other regions, and the capex plans on AI infrastructure spending have been confirmed which revitalized the sentiment on the AI theme. Third, year-to-date dollar weakness provides a tailwind for US large cap stocks with international exposure and at the same time is a headwind for non-US equities in local currency terms. For this reason, EPS revisions are likely to turn more positive in the US relative to other regions which might suffer from stronger currency. Fourth, the next three-to-four months have historically shown a negative seasonality of economic data and, as a result, European equity has outperformed US equity only 30% of the time during the summer (based on data since 1988)

Exhibit 3: EPS revisions have improved more for the US relative to other regions

EPS revisions breadth

We tactically upgraded US equities as we see support from light positioning, a weaker dollar, and strong earnings fundamentals in the near term. At the same time, we tactically downgraded European equities to underweight as we see the outperformance this year as already reflecting the improved macro outlook and we see headwinds on top line growth coming from the stronger EUR.

Within Europe, we continue to overweight European banks with an attractive dividend yield around 6% and cheap valuations which don’t reflect the strong fundamentals. Should the US outperform in the near term as we expect, that could provide opportunities for investors with a large US overweight to adjust their strategic asset allocation to be more balanced.

We have upgraded EM equities and FX following US-China tariff de-escalation. FX carry is increasingly appealing as we expect the economy will be in a muddle through environment – not too hot to drive yields materially higher, and not too cold to create a growth scare. Within FX, we like EM currencies that offer high real carry, including BRL and INR.

In a similar vein, we believe an environment of carry doing better and yields remaining high, worsens the case to owning safe-havens, at least on a tactical horizon. We therefore remove our tactical long positions in the JPY and gold, with both having enjoyed strong year-to-date performance and may be challenged by crowded positioning.

Asset class views