1Q2026: Emerging Markets Expected Returns

As of year-end 2025, Emerging Markets (EM) have begun to challenge “U.S. exceptionalism,” driven by shifting growth dynamics and a turbulent U.S. political landscape. While the S&P 500 remains at high valuation premiums, a CAPE-based analysis suggests superior expected returns in “cheap” EM markets like Brazil, particularly as EM earnings are projected to finally break out of a 14-year plateau in 2026.

Emerging Markets for the twelve months ending in March 2026 outperformed the S&P 500 by 10%. The East Asian tech powerhouses, Korea and Taiwan, and Latin America (with the exception of Argentina) have led the way, while Southeast Asia continues to sputter.

Over the past decade, EM stocks have underperformed the S&P 500 in a persistent and dramatic manner. During this period, EM stocks returned 5.3% annually in USD terms, compared to 12.3% for the S&P 500. Of the larger markets significant to EM investors, only Taiwan delivered attractive returns, though small markets like Argentina and Peru have also provided high total returns. China has been a consistent underperformer and again trailed the MSCI EM Index on a one-year and ten-year basis, providing further reason for investors to turn their attention toward the MSCI EM ex-China Index.


________________________________________
The Shift in U.S. Exceptionalism
The recent strength in international and emerging markets can be explained by hopes that growth is shifting away from the U.S. relative to the rest of the world. This has led to dollar weakness and triggered capital flows out of U.S. assets, raising tentative concerns that the long period of “U.S. exceptionalism” may be faltering. The remarkably turbulent first year of the second Trump Administration may be contributing to fears that the U.S. is no longer the reliable partner or safe haven for capital it was once reputed to be. The war in Iran caused a surprisingly small appreciation of the dollar, despite continued massive inflows of foreign funds into U.S. tech stocks.
The remarkable strength of the S&P 500 over the past decade can be attributed largely to two factors:

1. Remarkable expansion in profit margins: Roughly 60% of which was driven by lower interest rates and globalization—two trends now clearly in reverse.
2. Expansion of earnings multiples: This has brought valuations to extremely high levels by most measures.

The extraordinary profitability of U.S. tech titans over the past decade drove margins and earnings to record levels. Meanwhile, many other companies abroad have experienced a prolonged earnings depression. As shown below, MSCI EM earnings in nominal dollar terms are at the same levels they were in 2011–2012, while S&P earnings have nearly tripled. If earnings estimates for 2026 are correct, EM earnings will finally surpass the levels previously reached in 2010–2013.

The valuation premium of the S&P 500 over the MSCI EM Index closed the quarter at a moderate level, close to the 25-year average and well below the peaks of 2000–2001 and 2015–2016. This rising premium over the last three decades may reflect the U.S. market’s transition from capital-intensive cyclical businesses to capital-light companies with persistent, rising monopolistic profits. Unfortunately, this transition has not taken place in emerging markets—except briefly in China, until President Xi curtailed the tech sector to “safeguard social harmony.”

However, the valuation premium may have peaked. America’s tech titans have reached very high valuations and may face lower future profitability due to heavy investment in the capital-intensive and highly competitive AI sector.
________________________________________
Earnings and CAPE Analysis
The table below estimates current expected returns for emerging markets and the S&P 500 based on a CAPE ratio analysis. The Cyclically Adjusted Price-Earnings (CAPE) ratio—the average of inflation-adjusted earnings over the past ten years—helps smooth out cyclicality. This tool is especially useful for volatile assets like EM stocks and has gained popularity through the work of Professor Robert Shiller.

We use dollarized data to account for currency trends, and seven-year expected returns are calculated assuming each country’s CAPE ratio will revert to its historical average. Earnings are adjusted for each country’s position in the business cycle and are assumed to grow in line with nominal GDP projections from the IMF’s October 2025 World Economic Outlook.
As logic dictates, countries with “cheap” CAPE ratios (below their historical average) tend to have higher expected returns. This model relies on two assumptions:
• Current CAPE levels relative to historical averages are unjustified. * Market forces will eventually correct the discrepancy. Historical data strongly supports the second assumption over seven-to-ten-year periods, though rarely in the short term. The model may give a false signal if a country’s historical average is out of sync with its current growth prospects; for example, one could argue that current prospects in Chile or the Philippines do not justify their historically high CAPE ratios.
________________________________________
Market Outlook
The following chart shows MSCI EM country returns for the past 12 months, organized by their CAPE scores as of December 2024. With the exceptions of the Philippines and Turkey, the cheapest markets have performed well, while more expensive markets have underperformed. The impact of the current explosive semiconductor cycle on Korea and Taiwan is somewhat distorting the picture. When “cheap” markets show short-term outperformance, the combination of value and momentum is compelling.

Looking ahead, the Philippines and Indonesia appear very cheap and may benefit from an economic recovery phase. Colombia, Brazil, and Peru remain cheap with significant price momentum, with Brazil also benefiting from early-cycle dynamics. Chile is no longer cheap but may benefit from high copper prices and a new pro-business government.

After its recent underperformance, India no longer looks expensive. The negative effect of the war on India’s economy and stock prices may provide a good opportunity to invest in EM’s soundest long-term growth story. Conversely, expensive markets—Korea, Taiwan, the U.S., Argentina, and China—may benefit from continued momentum but will require positive earnings surprises to achieve superior performance.

The Big Mac Index: Global Currency Analysis (2000–2026)

 

The Big Mac Index (BMI) provides an insightful, if superficial, view of the value of international currencies and how countries manage them. The BMI, which has been compiled by The Economist magazine since 1986, compares the dollar price of a Big Mac sandwich in approximately 50 countries worldwide. It serves as an alternative measure of the relative cost of living, incorporating inputs from the farm, manufacturing, and service sectors, as well as taxes and regulations. Over time, it provides insight into the relative valuation of different currencies.

The chart below illustrates the change in the price of a Big Mac from 2000 to 2026. In the United States, the price of a Big Mac rose by 144% during this period—significantly more than the 98% increase in the U.S. Consumer Price Index (CPI). The chart highlights striking variations in price changes, ranging from a 300% increase in Poland to nearly no increase in Japan, Taiwan, and India.

The rankings of the index for the past 25 years for a selection of emerging markets (EM) and developed countries are shown in the table below. The table is color-coded: developed countries in black, EM commodity producers in red, and the remaining EM countries in green. This period spans an extraordinarily turbulent economic environment, including the China “Shock,” the commodity super-cycle, the Great Financial Crisis, the COVID-19 shock, and the beginning of deglobalization.

The last 15 years can be characterized as a period of “American Exceptionalism,” driven by the shale revolution and the global dominance of Silicon Valley’s tech titans, which led to significant dollar appreciation. At the same time, commodity prices were subdued. However, a long-overdue process of dollar weakening may have started in 2025.

Key Trends by Category

The table highlights several trends over this period, best observed through the color-coded categories:

 

  • Developed Countries: These economies have maintained a relatively narrow range of currency values relative to each other. Although the U.S. dollar has depreciated over the past year, it remains in the top third of the table, as it has consistently throughout the period. The Scandinavian countries, Britain, and Switzerland have stayed within a stable range near the top. Even Canada and Australia—both major commodity producers—have remained within a relatively tight range, though they are more volatile than other developed economies. A notable exception is Japan, which has experienced an extraordinary devaluation of the yen due to chronic deflation and quantitative easing. Furthermore, Japan is the only developed country (alongside its East Asian neighbors) consistently intent on managing its currency downward to maintain industrial competitiveness and exports.
  • Emerging Markets (Excluding Commodity-Dependent Countries): These countries can be divided into two distinct groups:
    • Mercantilist Economies: Taiwan, South Korea, China, Thailand, Malaysia, and Vietnam have prioritized export competitiveness. This has led to remarkable stability in the index, positioning them consistently in the bottom third. While these nations were among the biggest beneficiaries of hyper-globalization, they now stand to lose from deglobalization. The cases of South Korea and Taiwan are particularly striking: despite their increasing wealth, their currencies have become more competitive in BMI terms. Given their strategic alliances with the U.S., strong pressure from the Trump administration regarding tariffs and currency realignment is expected. These countries find themselves caught between the U.S. and China, facing the dual challenge of Chinese export competition and the threat of U.S. tariffs.
    • Market-Oriented Economies: Countries such as Turkey, Poland, India, and the Philippines show little commitment to currency stability. They experience broad exchange rate fluctuations—driven by volatile trade and capital flows—which can undermine export competitiveness. Poland, in contrast to the Asian mercantilists, has allowed for a consistent appreciation of the zloty as the nation has grown wealthier.
  • Commodity-Dependent Emerging Markets: These nations experience high levels of currency and economic instability. Over the past 25 years, free capital flows have exacerbated commodity-driven currency cycles, leading to extreme volatility due to “hot money” inflows and capital flight. This instability has contributed to acute deindustrialization in many of these economies. Argentina’s recent experience is particularly revealing: since 2010, Argentina has moved from the bottom of the table to the top third. Similarly, Brazil had one of the world’s most expensive Big Macs in both 2010 and 2015, exceeding even perennially expensive countries such as Sweden and Denmark. Among commodity-linked currencies, Indonesia stands out as an exception, behaving more like an “Asian Tiger” currency with relatively low volatility. Undoubtedly, the currencies of commodity producers will appreciate significantly if commodity prices continue to rally as they did during 2025.

Conclusion

In the current landscape of trade wars, shifting economic alliances, and increasing geopolitical tensions, currency realignment is becoming an essential tool for policymakers. The trends highlighted by the Big Mac Index reflect deeper structural shifts in the global economy—from the rise and fall of American exceptionalism to the challenges faced by both developed and emerging markets. As the forces of deglobalization take hold, nations will likely respond with a mix of tariffs, industrial policies, and monetary interventions to maintain competitiveness. The coming years will test the resilience of global currencies, determining which economies can adapt to this new era of economic realignment.

Global Industrial Policy and the Rise of the New Consensus

A new consensus has been building in Western policy and academic circles that, for both strategic and economic reasons, countries can no longer passively cede industrial capacity to committed mercantilist powers. Arguments in favor of restrictions on trade and capital flows—considered extremist during the neoliberal Washington Consensus (1980–2010)—have now moved into the mainstream. It has dawned on policymakers that not having an industrial policy is the worst kind of industrial policy, as it leaves a nation at the mercy of others.

This change in ideological climate provides a major opportunity for those countries that missed out on the globalization boom to return to relevance. Countries with large consumer markets, such as the United States, Brazil, India, and Indonesia, now have a chance to recapture domestic demand as they reshore industrial activities. Unfortunately, this is easier said than done, because mobilizing sustained political support for these policies remains a significant challenge.

The Fletcher-Fasteau Framework

Marc Fasteau and Ian Fletcher’s 2024 book, Industrial Policy for the United States: Winning the Competition for Good Jobs and High-Value Industries, has become a significant reference point in Washington’s policy circles, positioned as an “authoritative tome” for a new era of American economic strategy. The authors argue that the United States must abandon its “free trade” orthodoxy in favor of a robust industrial policy. They contend that decades of laissez-faire economics have led to deindustrialization, a massive trade deficit, and a dangerous dependence on foreign supply chains.

The book provides a rigorous intellectual framework for ideas that were once considered fringe but are now central to the bipartisan “New Washington Consensus.” While the book focuses on the U.S., its “advantageous industries” framework is highly relevant to large emerging markets such as India, Brazil, and Indonesia. These nations, like the United States, have lost relevance in manufacturing and must respond to the onslaught of Chinese exports.

To reverse this decline, the authors propose a Three-Pillar Framework:

  • Strategic Innovation Support: Government must fund the entire lifecycle of “advantageous industries”—sectors with high growth potential and technological “path dependence”—to bridge the “valley of death” between invention and commercial manufacturing.

  • Protection Against Subsidized Competition: Implementing tariffs and anti-dumping measures to shield domestic “mid-tech” and high-tech sectors from foreign subsidies.

  • Competitive Currency: Managing the U.S. dollar (via a “market access charge”) to regulate capital inflows and avoid overvaluation, which currently acts as an implicit tax on American exports.

The authors anchor their argument in American history—citing Alexander Hamilton and the development of the internet—to prove that government intervention is a traditional, rather than radical, engine of prosperity. While they draw inspiration from the success of Japan, Taiwan, Korea, and China, they argue that a “copy-paste” approach would fail due to the unique political, legal, and economic structure of the U.S. Therefore, unlike the “East Asia Development Model,” they advocate for a market-based approach focused on frontier industries necessary for resilience and autonomy. Furthermore, the framework aims to foster quality, middle-class jobs and rejects the wage repression characteristic of East Asia.

The Political Obstacle

The most formidable obstacle to implementing a coherent reindustrialization strategy for the U.S., as for many other countries, is the lack of sustainable political support. In the brief period that industrial policy has been back in vogue, we have seen the plans of the Biden administration largely dismantled and replaced by erratic policies that lack legislative support and fail to provide the long-term clarity needed to secure investments.

In Brazil, a long history of “stop-and-go” policies has discredited industrial policy. Successive administrations are prone to abandoning prior commitments, making investment planning impossible. Neither of the two major political forces prioritizes industrial policy: the focus of Lula’s leftist Workers’ Party (PT) is on expanding welfare distribution, while the Bolsonaro clan favors a naïve free-market path similar to that followed by Javier Milei in Argentina. Moreover, Brazil suffers from a double dose of chronic “Dutch Disease,” where unstable trade and capital flows lead to high currency volatility and boom-to-bust credit cycles. Since 1980, Brazil has undergone an extreme process of deindustrialization, reducing the lobbying power of industry relative to the financial, service, and agro-industrial sectors.

Indonesia faces similar complications; it has lost relevance in industrial exports and remains stuck in a middle-income trap. Current policy efforts are aimed at adding value to commodity resources (bauxite, copper, tin, and palm oil), but these investments are capital-intensive and do not provide significant employment.

The Indian Exception

Fortunately, we can look to India with much more optimism. India did not benefit from the export boom of neoglobalism, but unlike Brazil, its economy still prospered. India has remained a relatively closed economy with a politically powerful industrial sector. Decades of policy reforms aimed at unshackling the economy and liberating private initiative have triggered high growth. Importantly, these reforms are broadly supported by the political class and the influential “national champion” family business groups.

India’s current industrial policy is best understood as a transition from defensive import substitution toward a proactive, resilience-based manufacturing strategy. Facing the “triple threat” of Chinese competition, volatile U.S. tariff regimes, and a fraying international trading system, New Delhi has recalibrated its Atmanirbhar Bharat (Self-Reliant India) framework.

India’s Strategic Outlines:

  1. The Pivot to Ecosystems: The 2026 budget prioritizes “outcome-oriented” support. Instead of just subsidizing production, the government is incentivizing the creation of entire supply chains—raw materials, components, and deep-tech R&D—to anchor manufacturing within India.

  2. Navigating Chinese Competition: India maintains strict scrutiny on Chinese capital in sensitive sectors while using industrial policy to diversify. By building domestic capability in coking coal and rare earth corridors, India aims to “de-risk” its reliance on Chinese inputs.

  3. Adapting to U.S. Tariffs: Following the February 2026 Supreme Court ruling that struck down previous tariff regimes, India is navigating the new 15% flat surcharge under Section 122 by negotiating sector-specific exemptions and aggressively pursuing alternative trade agreements, such as the 2026 India-EU Free Trade Agreement.

  4. Strategic Autonomy: India is engaging in “multi-alignment,” signing FTAs with the EU and UAE while participating in high-tech partnerships to secure access to technology. It is also aligning its industrial standards with global sustainability norms (like the EU’s CBAM) to capture Western capital shifting toward “green” and transparent production.

India is betting that its large domestic market and democratic stability can act as a buffer against global trade volatility, allowing it to build the industrial infrastructure necessary to compete on cost and quality.

Paul Kennedy’s The Rise and Fall of Great Powers; 40 Years Later

“If a state overextends itself strategically… it runs the risk that the potential benefits from external expansion will be outweighed by the great expense of it all.” — Paul Kennedy

Paul Kennedy’s 1987 book, The Rise and Fall of the Great Powers, is one of the most influential works of geopolitical strategy and economic history. Its central thesis—imperial overstretch—became a staple of political discourse, especially as the Cold War reached its endgame. Nearly 40 years after the book’s publication, it is insightful to review its predictions, and provide an update on the author’s current views.

Core Summary: The Thesis of “Imperial Overstretch”

Kennedy examines the movement of global power centers from 1500 to the late 20th century. His argument rests on a fundamental relationship between economics and military power:

  • Relative Economic Growth: A nation’s power is never absolute; it is always relative to its rivals. Wealth is the indispensable foundation of military strength.
  • The Lag Effect: Military power tends to lag behind economic shifts. A nation might remain a military superpower even after its share of global GDP has begun to shrink.
  • Imperial Overstretch: This occurs when a Great Power’s global commitments (colonies, bases, alliances) exceed its economic capacity to maintain them. Eventually, the cost of “policing” the world drains the very economy that sustains the military, leading to inevitable decline.

What He Got Right

Kennedy’s long-term historical analysis proved remarkably durable in several key areas:

  • The Rise of China: Kennedy was prophetic about China’s potential. In 1987, he identified China as the “wild card,” predicting that if its economic reforms continued, it would inevitably re-emerge as a top-tier Great Power.
  • The Vulnerability of the USSR: While many in Washington still feared a Soviet juggernaut, Kennedy correctly identified that the Soviet Union’s stagnant, command-based economy could not indefinitely sustain its massive military expenditures.
  • The Role of Technology: He correctly emphasized that shifts in industrial and technological bases (like the transition from coal to oil, or from steel to microchips) are the true drivers of who wins “the next war.”
  • The Relative Decline of the U.S.: He was right that the U.S. share of global GDP would shrink from its post-WWII high (roughly 50%) to a more “normal” level as other nations recovered and developed. His conclusion that U.S. hegemony was following the path of the decline of the British empire by pursuing deindustrialization and financialization of the economy was premature but looks prescient today.
  • Wealth Concentration and the Rise of Populism: He predicted, also prematurely, that economic neoliberalism and the form of American capitalism leading to wealth concentration and disempowerment of the working class would lead to social strife and populism.

What He Overlooked

While the book is brilliant, history threw a few curveballs that Kennedy didn’t fully account for:

  • The Speed of the Soviet Collapse: Kennedy viewed the USSR as a “Great Power in decline,” but he expected a slow, agonizing slide over decades. He did not foresee the total, sudden internal collapse of 1991.
  • The Resiliency of the American Economy: Kennedy was somewhat pessimistic about the U.S. in the late 80s (the “Rust Belt” era). He underestimated the U.S.’s ability to reinvent itself through the digital revolution and the dominance of Silicon Valley, which fueled a massive economic resurgence in the 1990s.
  • The “Unipolar Moment”: He didn’t anticipate that the fall of the USSR would leave the U.S. as the world’s sole superpower for twenty years. Instead of a balanced multipolar world arriving quickly, the U.S. actually expanded its global commitments.
  • Soft Power: Kennedy’s analysis is heavily “hard power” (guns and money). He gave less weight to “soft power”—the cultural, ideological, and institutional influence that has allowed the U.S. to maintain alliances even when its share of global GDP dipped.

 Kennedy’s Current View

Kennedy’s work remains a “must-read” because his core warning still resonates: Wealth is power, but power is expensive. Today, as the U.S. debates its role in a “multipolar” world and watches China’s economic trajectory, the ghost of “imperial overstretch” continues to haunt every budget meeting in the Pentagon.

Kennedy’s recent commentary, including reflections in early 2026, suggests that while the “Imperial Overstretch” thesis remains his North Star, the variables have shifted toward a tripolar world dominated by the U.S., China, and India.

Here is how he views the current struggle through the lenses of manufacturing, deindustrialization, and debt. 

The 2026 Perspective: The Tripolar Struggle

Kennedy’s current view suggests a transition to a tripolar global order dominated by the U.S., China, and India.

Factor United States China India
Primary Strength Finance / Tech Manufacturing Demographics / Software
Geopolitical Goal Hemispheric Defense Regional Hegemony Multipolar Asia / Global South
Major Risk Debt & Deindustrialization Aging Population Internal Reform Resistance

The “Retrenchment” Solution

Kennedy’s current advice to American policymakers is to embrace “sensible retrenchment.” He argues that the U.S. should:

  • Moderate Ambitions: Stop trying to be the “police of the world” in regions like the Middle East where interests are no longer primary.
  • Shift the Burden: Encourage allies like India and Japan to take over regional security.
  • Manage Decline: The goal for U.S. statesmanship is to ensure that the erosion of its relative position happens “slowly and smoothly” rather than through a sudden, policy-induced crash.

Manufacturing Might vs. Financialization

Kennedy remains a “materialist” historian who believes that statistics (like GDP) are often ephemeral compared to physical productive capacity.

  • The De-industrialization Trap: Kennedy remains deeply concerned that this retrenchment is paired with a “financialized” economy. He famously remarked that “Shipbuilding is real,” warning that if the U.S. focuses on “deals” and finance while China focuses on physical production and infrastructure, the U.S. will lack the “hard punch” necessary to back up its Monroe Doctrine assertions. Kennedy’s focus on shipbuilding as a metric for “hard punch” reflects his belief that a nation’s ability to physically project power is the only true hedge against imperial decline. (“Measurements of power that are merely statistical don’t have any hard punch to them… Shipbuilding is real.” — Paul Kennedy (2025/2026 reflections).
  • The Cost of Complexity: He has expressed “angst” regarding America’s reliance on 50-year-old aircraft carriers that are enormously expensive to maintain and increasingly vulnerable to new technologies like “super submarines” and AI-driven missiles.
  • Deindustrialization as a Strategic Risk: He sees the shift of the industrial center to the East not just as an economic trend, but as a direct transfer of the “hard punch” of power.

Debt and Foreign Liabilities: The Achilles’ Heel?

Kennedy’s views on the “dollar” and U.S. debt have evolved but remain cautious:

Issue Kennedy’s Current Perspective
The U.S. Dollar He previously saw the dollar as an “Achilles’ heel,” but now acknowledges its remarkable persistence. He notes that because so many global financial instruments are dollar-denominated, there is no immediate rival, which provides the U.S. a unique fiscal “satisfaction” even amidst military anxiety.
Rising Debt He continues to warn that “profligacy” is punished in power politics. He views the habit of borrowing to fund “guns and butter” as a classic symptom of a declining power struggling to manage its preferences.
Foreign Liabilities The concern is that if foreign creditors (like China) lose faith or intentionally trade against the dollar, it could trigger a “run” that the U.S. cannot manage. However, he admits this hasn’t happened yet because of a lack of alternatives.

 

The Rise of India: The “Second Pole” in Asia

Kennedy views India as the “wild card” that has finally arrived. In his recent commentary, he highlights several key factors that distinguish India’s rise:

  • Imitating the Chinese Blueprint: Kennedy observes that India is closely following China’s path—focusing on aggregate economic growth and military modernization. He notes that Indian leadership has abandoned post-colonial hesitations about the use of force, increasingly viewing hard power as a legitimate tool to protect national interests.
  • Strategic “Space”: Unlike the crowded European borders of 1914, Kennedy argues the U.S., China, and India have enough “geographical and strategic space” between them. He believes this “tripolar” balance might actually be more stable than previous eras because no single power needs to “stand on the toes” of the others to survive.
  • The Democratic Distinction: While he acknowledges India’s democratic system, Kennedy remains a realist; he argues that in terms of hard power politics, India and China act and react in remarkably similar ways, prioritizing national sovereignty and regional dominance over international “preaching.”

The “Monroe Doctrine 2.0” and Trumpism

Kennedy sees the revival of the Monroe Doctrine under the current administration as a classic symptom of “sensible but impulsive retrenchment.” * The “Trump Corollary”: Analysts and historians reflecting on Kennedy’s work see the current “America First” posture as a formal “Trump Corollary” to the Monroe Doctrine. It signals a retreat from being the “global police” in favor of reasserting absolute dominance over the Western Hemisphere.

The Trade-Off: Kennedy views this as a double-edged sword. On one hand, focusing on the “immediate neighborhood” (protecting borders and controlling the Americas) reduces the risk of “Imperial Overstretch” in places like the Middle East. On the other hand, it risks turning the U.S. into a “hemispheric power” rather than a global one, potentially ceding the rest of the world to Chinese and Indian influence.

Conclusion: The Persistence of the Overstretch

Nearly four decades after its debut, Paul Kennedy’s thesis has transitioned from a controversial prediction to a foundational lens for understanding the 21st century. While the “unipolar moment” of the 1990s temporarily masked the symptoms of imperial fatigue, the realities of 2026—characterized by a tripolar rivalry between the U.S., China, and India—have brought his warnings back to the forefront of global strategy.

The enduring relevance of The Rise and Fall of the Great Powers lies in its cold, mathematical insistence that geopolitical influence is a derivative of industrial and economic health. As the United States grapples with high debt, deindustrialization, and the strategic pivot toward a “Monroe Doctrine 2.0,” it is essentially following the script Kennedy wrote in 1987. Whether through “sensible retrenchment” or a chaotic retreat, the U.S. is currently testing Kennedy’s ultimate question: can a Great Power manage its relative decline with enough grace to remain a leader in a world it no longer dictates?

Ultimately, Kennedy’s work serves as a reminder that while ideologies and leaders change, the iron laws of “hard power” do not. In a world where “shipbuilding is real,” the nations that thrive will be those that balance their global ambitions with the physical and fiscal capacity to sustain them.

The U.S. dollar: From Public Good to Private Weapon

“China needs to build a powerful currency that could be widely used in international trade, investment and foreign exchange markets, and attain reserve currency status,” Xi Jinping, January 2026

The hegemony of the United States dollar has long been the bedrock of global economic stability, functioning as a “global public good” that facilitates seamless trade and investment. However, two seminal 2026 papers published via the Carnegie Endowment for International Peace suggest that this foundation is beginning to crack. In “The US Dollar System as a Source of International Disorder,” (Link) Daniel Davies and Henry Farrell argue that the strategic weaponization of the dollar has transformed it from a stabilizing force into a primary driver of global friction. Complementing this view, Alexander Evans’ “The Hollow Dollar?” (Link)  explores the internal structural decay of the currency’s institutional reliability. Together, these works present a troubling portrait of a financial superpower at a crossroads, where short-term geopolitical leverage may be coming at the cost of long-term systemic integrity.

  1. From Homeostasis to Disorder

Davies and Farrell frame the post-WWII financial system as originally homeostatic—meaning it possessed self-regulating feedback loops that maintained stability even when faced with external shocks.

  • The Original Goal: Dollar centrality (using the dollar as the “vehicle currency” for global trade) was intended to lower transaction costs and create a predictable environment for all nations.
  • The Shift: After 9/11, the US began “weaponizing” this centrality. By controlling the “plumbing” of global finance—such as the SWIFT network and dollar clearing banks—the US gained the power to sever adversaries from the world economy.
  1. The “Weaponization” Feedback Loop

The core of their paper describes a dangerous cycle that has replaced the old stability:

  1. Exploitation: The US leverages dollar centrality for national security (e.g., aggressive sanctions on Russia, Iran, or North Korea).
  2. Circumvention: Fearing they might be the next target, other countries—including allies like the EU—take steps to evade US power by building alternative payment systems or diversifying reserves.
  3. Escalation: The US perceives this evasion as a threat and “doubles down,” scaling up financial coercion to force countries back into the system.

“The more that other countries look to escape US financial coercion, the more the US will scale it up to pin them into place.”

  1. Key Disruptors: Private Actors and Tech

Farrell and Davies highlight two modern factors accelerating this disorder:

  • Bank Over-Compliance: Terrified of US fines, global banks have adopted “zero-risk” policies. This “de-risking” often cuts off legitimate businesses in developing nations, fueling resentment and the search for alternatives.
  • Cryptocurrency & Digital Assets: The introduction of US-backed stablecoins and other digital assets provides new, less-regulated avenues. While these make the system harder for the US to control, they also increase overall volatility.
  1. The Structural Decay: “The Hollow Dollar?”

While Davies and Farrell focus on strategic breakdown, Alexander Evans focuses on structural decay. Evans argues that while the dollar still appears dominant on the surface, it is becoming “hollow.”

  • The Illusion of Centrality: High reserve percentages are “lagging indicators.” The dollar’s utility is declining as “mini-systems” (like BRICS-pay or the digital yuan) handle more local trade.
  • Decoupling from Values: As US domestic politics become more volatile and transactional, the dollar loses its “safe haven” status and its identity as a global public good.
  • The “Sudden Snap” Risk: Evans suggests the dollar will not decline gradually. Like a hollowed-out structure, it may maintain its form until a specific crisis causes it to “snap” due to a lack of internal trust.

Conclusion

The synthesized findings of Davies, Farrell, and Evans suggest that the US is currently trading its long-term financial credibility for short-term geopolitical wins. If the dollar system is indeed a “source of disorder,” then the “hollow dollar” is the inevitable, fragile result. By treating the global financial infrastructure as a bureaucratic weapon of first resort, the United States risks incentivizing a multipolar world split between incompatible currency blocs. Ultimately, if the US continues to prioritize coercion over the maintenance of a rules-based order, it may find itself presiding over a fragmented global economy where the dollar remains central in name only, stripped of the trust that once gave it power.

The Transactional Turn: American Exceptionalism and the Rise of Mercantilist Imperialism

 

Throughout its history, the United States has transitioned between eras of systemic vitality and periods of structural malaise. These cycles dictate the direction of global capital, the strength of the dollar, and the ultimate trajectory of asset prices. For the past fifteen years, investors have benefited from a cycle of American vigor, fueled by technological dominance and energy independence. However, as these tailwinds fade, the United States is pivoting toward a “might-makes-right” transactionalism—a shift that fundamentally alters the pillars of American Exceptionalism and signals a transition into a new era of malaise.

Strategic Asset Allocation for the 2026–2030 Transition

As we move away from the “Vigor” phase, the following table summarizes how to reposition a portfolio for a world defined by a weakening dollar and rising geopolitical friction.

Current Exposure (Vigor) Strategic Shift (Malaise) Rational
U.S. Growth / NASDAQ International Value / EM Captures growth in regions with lower valuations and better demographics.
Long-Duration Bonds Commodities & Real Assets Protects purchasing power against dollar devaluation and structural inflation.
U.S. Dollar Cash Hard Assets / Gold Hedges against the erosion of the dollar’s “safe haven” status.
Global Tech Titans Energy & Defense (Non-U.S.) Positions for a world of increased military spending and resource scarcity.

The Era of Outperformance: 2012–2025

The United States rebounded from the Great Financial Crisis faster than the rest of the world (ROW) and sustained higher growth throughout the 2012–2025 period. Several key factors supported this U.S. outperformance:

  1. Energy Independence: The exploitation of shale oil and gas resources converted the U.S. from a major hydrocarbon importer to a large-scale exporter.
  2. Tech Dominance: The extraordinary profitability and cash generation of Silicon Valley’s “winner-take-all” global titans drove U.S. stock valuations back to the stratospheric levels seen during the TMT (Technology, Media, and Telecommunications) bubble.
  3. Policy Support: Stimulative fiscal and monetary policies shielded the economy from deep recessions and boosted corporate profits.
  4. Currency Strength: The persistent strengthening of the U.S. dollar lowered borrowing costs, suppressed inflation, and attracted foreign capital.
  5. Labor Dynamics: High levels of immigration contributed to labor supply and helped maintain low inflation.

Conversely, growth in the Rest of the World was hampered by:

  • European Stagnation: Tighter financial conditions and recurring crises in Europe and emerging markets led to prolonged low GDP growth.
  • Geopolitical Instability: Brexit and rising political instability across Europe, exacerbated by the Russian invasion of Ukraine, necessitated vastly greater military spending.
  • China’s Slowdown: The end of China’s “Economic Miracle,” marked by demographic collapse, plummeting productivity, and a massive real estate bubble that eroded private savings and consumption.
  • Structural Shifts in Beijing: The radicalization of Chinese domestic and foreign policy under Xi Jinping, which prioritizes Communist Party control and economic self-sufficiency over consumption and growth.

The Transition to Malaise

Every cycle of American vigor is accompanied by a strong dollar, falling commodity prices, and rising domestic asset prices. Conversely, a cycle of “malaise” is typically marked by a depreciating dollar, rising commodity prices, and higher relative growth in the ROW. Historically, these phases are defined by the rise of a foreign power that symbolizes relative U.S. decline: Germany in the 1970s, Japan in the 1980s, and China in the 2000s.

The following chart depicts the U.S. Real Effective Exchange Rate (REER) over the past 60 years with the purpose of illustrating how dollar strength and weakness is intrinsically linked with the long-term cycles of vigor and malaise of the U.S economy. The connection exists because both these cycles are linked to capital flows, interest rates and growth rates.

We are now entering a transition from vigor to malaise. The drivers of the 2012–2025 expansion have largely pivoted:

  1. Shale Plateau: The shale boom has matured, and production is expected to plateau at current levels.
  2. Tech Maturity: Tech margins and valuations are at historic highs, while capital intensity is increasing.
  3. Fiscal Constraints: Record-high government debt and elevated interest rates are raising serious concerns regarding fiscal deficits.
  4. Dollar Reversal: The U.S. Real Effective Exchange Rate (REER) peaked in January 2025 after appreciating 55.2% from its 2011 bottom—surpassing peaks in 1970, 1985, and 2002. Just as the 1970 high led to the end of Bretton Woods and the 1985 high prompted the Plaza Accord, the current overvaluation has become a political target. Under the Trump Administration’s pressure, the dollar has already lost 5% of its value in 2025.
  5. Border Policy: Immigration policy has shifted from an “open door” approach to strict control.

The Erosion of Exceptionalism

Beyond economics, the Trump Administration has challenged the traditional pillars of “American Exceptionalism.” Both domestic and foreign policies have shifted from values-based leadership to a transactional, “might-makes-right” framework:

  • The End of Pax Americana: The retreat from global alliances has diminished the U.S. ability to shape the rules-based order and maintain a dollar-centric financial system. Just in recent weeks we have seen “middle powers” seeking alternative partnerships that bypass U.S. arbitrariness, such as Canada’s trade agreement with China, Europe’s trade agreement with Mercosur and Korean rapprochement with China and Japan.
  • Academic Decline: Policies are undermining the capacity of American universities to conduct world-class research and attract global talent.
  • Institutional Erosion: The undermining of the “checks and balances” inherent in the federal system and the perceived weaponization of the Department of Justice have threatened the traditional U.S. rule of law.

Investment Implications for the New Cycle

 

As the drivers of U.S. outperformance pivot, the investment playbook must shift from a “US-only” growth focus to a more diversified, value-oriented strategy. Investors should consider reducing exposure to high-multiple domestic tech titans in favor of ex-U.S. equities, particularly in markets that benefit from a weaker dollar and a resurgence in commodity demand. With the era of “cheap labor and cheap energy” ending, real assets—including commodities, gold, and infrastructure—likely offer better protection against the inflationary pressures of a devalued currency. Finally, given the rising fiscal deficits and the end of the “strong dollar” policy, a move toward shorter-duration fixed income or inflation-linked securities may be necessary to hedge against sovereign credit concerns and interest rate volatility.

Year-end 2025: Emerging Markets Expected Returns

Executive Summary: As of year-end 2025, Emerging Markets have begun to challenge U.S. “exceptionalism,” driven by shifting growth dynamics and a turbulent U.S. political landscape. While the S&P 500 remains at historically high valuation premiums, a CAPE-based analysis suggests superior expected returns in “cheap” EM markets like Brazil and Turkey, particularly as EM earnings are projected to finally break out of a 14-year plateau in 2026.

Emerging Market (EM) stocks in 2025 outperformed the S&P 500 for only the second time in the past decade, and the third time since the end of the China/commodity boom in 2012. Latin America, with the exception of Argentina, led the way, while Southeast Asia and Turkey continued to sputter. China once again trailed the MSCI EM Index, providing further reason for investors to turn their attention toward the MSCI EM ex-China Index.


Over the past decade, EM stocks have underperformed the S&P 500 in a persistent and dramatic manner.  Of the larger markets significant to EM investors, only India and Taiwan delivered attractive returns.

EM stocks continue to trail the U.S. market by a large margin over the ten-year horizon. During this period, EM stocks returned 4.8% annually in USD terms, compared to 13% for the S&P 500.Not ably, the MSCI EM ex-China Index outperformed the standard MSCI EM Index by a significant 1.5% annually. Taiwan, driven by TSMC and other tech stocks, dominated the decade, with traditional Latin American commodity producers—Peru, Argentina, Colombia, and Brazil—not far behind. In contrast, China and Southeast Asia trailed significantly, mired in industrial overcapacity and deflation.

The Shift in U.S. Exceptionalism
The recent strength in international and emerging markets can be explained by hopes that growth is shifting away from the U.S. relative to the rest of the world. This has led to dollar weakness and triggered capital flows out of U.S. assets, raising tentative concerns that the long period of “U.S. exceptionalism” may be faltering. The remarkably turbulent first year of the second Trump Administration may be contributing to fears that the U.S. is no longer the reliable partner or safe haven for capital it was once reputed to be.
The strength of the S&P 500 over the past decade can be attributed largely to two factors: first, a remarkable expansion in profit margins (roughly 60% of which was driven by lower interest rates and globalization—two trends now clearly in reverse); and second, an expansion of earnings multiples, which has brought valuations to extremely high levels by most measures.
The valuation premium of the S&P 500 over the MSCI EM Index closed the quarter at a moderate level, close to the 25-year average and well below the peaks of 2000–2001 and 2015–2016. This rising premium over the last three decades may reflect the U.S. market’s transition from capital-intensive cyclical businesses to capital-light companies with persistent, rising monopolistic profits. Unfortunately, this transition has not taken place in emerging markets—except briefly in China, until President Xi curtailed the tech sector to “safeguard social harmony.” However, the valuation premium may have peaked. America’s tech titans have reached very high valuations and may face lower future profitability due to heavy investment in the capital-intensive and highly competitive AI sector.

Earnings and CAPE Analysis
The extraordinary profitability of U.S. tech titans over the past decade drove margins and earnings to record levels. Meanwhile, many other companies abroad have experienced a prolonged earnings depression. As shown below, MSCI EM earnings in nominal dollar terms are currently lower than they were in 2011–2012, while S&P earnings have nearly tripled. If earnings estimates for 2026 are correct, EM earnings will finally surpass the levels previously reached in 2010–2013.

The table below estimates current expected returns for emerging markets and the S&P 500 based on a CAPE ratio analysis. The Cyclically Adjusted Price-Earnings (CAPE) ratio—the average of inflation-adjusted earnings over the past ten years—helps smooth out cyclicality. This tool is especially useful for volatile assets like EM stocks and has gained popularity through the work of Professor Robert Shiller. We use dollarized data to account for currency trends, and seven-year expected returns are calculated assuming each country’s CAPE ratio will revert to its historical average. Earnings are adjusted for each country’s position in the business cycle and are assumed to grow in line with nominal GDP projections from the IMF’s October 2025 World Economic Outlook.

As logic dictates, countries with “cheap” CAPE ratios (below their historical average) tend to have higher expected returns. This model relies on two assumptions: first, that current CAPE levels relative to historical averages are unjustified; and second, that market forces will eventually correct the discrepancy. Historical data strongly supports the second assumption over seven-to-ten-year periods, though rarely in the short term. The model may give a false signal if a country’s historical average is out of sync with its current growth prospects; for example, one could argue that current prospects in Chile or the Philippines do not justify their historically high CAPE ratios.

Market Outlook
The following chart shows MSCI EM country returns for the past 12 months, organized by their CAPE scores as of December 2024. With the exceptions of the Philippines and Turkey, the cheapest markets  (left of the chart)have performed well, while more expensive markets (right of the chart) have underperformed. When “cheap” markets show short-term outperformance, the combination of value and momentum is compelling.


Looking ahead, Turkey and the Philippines appear very cheap and may benefit from an economic recovery phase. Colombia, Brazil, and Peru remain cheap with significant price momentum, with Brazil also benefiting from early-cycle dynamics. Chile is no longer cheap but may benefit from high copper prices and a new pro-business government. Conversely, expensive markets—Korea, Taiwan, the U.S., Argentina, and China—may benefit from continued momentum but will require positive earnings surprises to achieve superior performance.

Damn the Torpedoes: Full Speed Ahead for Emerging Markets

Emerging Market (EM) stocks in 2025 outperformed the S&P 500 for only the second time in the past decade, and the third time since the end of the China/commodity boom in 2012. Since that boom ended, total returns have been 510% for the S&P 500 compared to a miserable 83% for EM. This period has been defined by a remarkable phase of “American Exceptionalism,” while major emerging markets—with the notable exceptions of India and Taiwan—have been marked by malaise, torpor, and an extraordinary consistency in destroying shareholder capital. So, why should we be bullish on EM stocks now?

First, we can start with a technical argument based on recent trends and historical patterns. Second, in a later blog,we can speculate on the status of “American Exceptionalism” and its implications for asset prices.

The Technical Argument

  1. Momentum: Relative performance between EM and the S&P 500 historically trends for multiple years. Therefore, the significant outperformance EM saw in 2025 (33.5% vs. 17.3%) is, in itself, a strong reason to be optimistic about positive returns in 2026. This is particularly true for the MSCI EM ex-China index, which has significantly outperformed the broader MSCI EM index for the past 10 years and continued to do so in 2025, despite the recovery of China’s tech sector.
  2. The U.S. Dollar: A weakening U.S. dollar is historically highly correlated with positive EM stock returns. A weaker dollar stimulates economic activity and trade outside the U.S. by lowering debt-servicing and trade-financing costs and increasing the affordability of dollar-priced commodities. The dollar fell by 8% in 2025, as measured by the DXY index, and is now down by over 10% since its peak in October 2022. If the dollar is entering a typical down cycle, it could continue to weaken for several years. Two factors make this plausible: first, the Trump Administration is unique in its desire for a weaker currency to promote U.S. reindustrialization; second, the current trend of global de-dollarization is manifesting in rising gold prices and China’s determination to reduce dollar hegemony.
  3. Commodity Prices: The Industrial Metals Index and copper prices are historically highly correlated with EM stock prices. This connection is driven by three primary factors: the revenue dependence of commodity-exporting nations, industrial demand from manufacturing giants like China, and an inverse relationship with the U.S. dollar. As the charts below show, both indices have been rising sharply, supporting a continuation of the EM rally.

A Few Words of Caution

Several factors may still weigh on the bullish case for EM stocks:

  • U.S. GDP Resilience: U.S. growth continues to surprise to the upside, largely due to the persistence of the tech sector. Relatively high U.S. growth attracts capital from the rest of the world, which is typically bearish for EM assets.
  • Soft Commodity Prices: Weak prices for oil and agricultural commodities are deflationary, which is generally not supportive of EM stocks.

2Q2025 Emerging Markets Expected Returns

Emerging markets stocks outperformed the S&P 500 in the second quarter and first half of 2025 in a rare show of strength. China and Latin America led the way, while India sputtered.

Over the past year and decade, EM has underperformed the S&P 500 in a persistent and dramatic manner. Over the past 10 years, EM stocks have returned 4.8% annually in USD terms, compared to 13% for the S&P 500. Of the larger markets significant to EM investors, only India and Taiwan have delivered attractive returns.

The recent strength in international and emerging markets can be explained by hopes that a shift is occurring in the relative strength of growth away from the U.S. This has led to some dollar weakness and triggered capital flows out of U.S. assets, raising tentative concerns that a long period of U.S. “exceptionalism” may be faltering.

The strength of the S&P 500 over the past decade can be attributed largely to two factors: first, a remarkable decade-long expansion in profit margins, of which about 60% was driven by lower interest rates and globalization—two trends now clearly in reverse; and second, an expansion of earnings multiples, which has brought valuations to extremely high levels by most measures.

The valuation premium of the S&P 500 over the MSCI EM Index closed the quarter at elevated levels, surpassed only by the 2016–2018 and 1998–1999 periods. The rising valuation premium over the past three decades may reflect the U.S. market’s transition from being dominated by capital-intensive cyclical businesses to one dominated by capital-light companies with persistent and rising monopolistic profits. Unfortunately, this transition has not taken place in emerging markets—except briefly in China, until Chairman Xi curtailed the tech sector to “safeguard social harmony.” However, the valuation premium may have peaked and started to trend downward, as America’s tech titans have reached very high valuations and may face lower profitability in the future due to heavy investment in the highly capital-intensive and competitive AI sector.

The extraordinary profitability of America’s tech titans over the past decade drove profit margins and earnings to record levels. Meanwhile, many other companies in the U.S. and abroad have experienced a prolonged earnings depression. For example, as shown below, MSCI EM earnings in nominal dollar terms have not increased in about 15 years.

The chart below estimates the current expected returns for emerging markets and the S&P 500, based on a CAPE ratio analysis. The Cyclically Adjusted Price-Earnings (CAPE) ratio, which calculates the average of inflation-adjusted earnings over the past ten years, helps smooth out earnings cyclicality. This tool is especially useful for highly cyclical assets like emerging market stocks and has a long history of use among investors, gaining popularity more recently through the work of Professor Robert Shiller at Yale University. We use dollarized data to account for currency trends, and the seven-year expected returns are calculated assuming each country’s CAPE ratio will revert to its historical average over time. Earnings are adjusted according to each country’s position in the business cycle and are assumed to grow in line with nominal GDP projections from the IMF’s World Economic Outlook (April 2025).

As logic dictates, countries with “cheap” CAPE ratios below their historical average tend to have higher expected returns than those with CAPE ratios above their historical average. These expected returns rely on two key assumptions: first, that current CAPE levels relative to historical averages are unjustified; and second, that over time, market forces will correct the discrepancy. Historical data strongly supports the second assumption over seven- to ten-year periods, though not over the short term (one to three years). The model may give a false signal if a country’s historical CAPE average is out of sync with its current growth prospects. For example, one could argue that Chile’s current growth prospects do not justify its historically high CAPE ratios. The same may be true for the Philippines.

The following chart shows MSCI EM country returns for the past 12 months in relation to the markets with the highest seven-year expected returns as of mid-2024. Among the markets with high long-term expected returns, Colombia, Chile, Peru, Brazil, and the Philippines currently exhibit strong momentum characteristics. The chart demonstrates that the CAPE ratio was not particularly predictive of performance over this one-year period, as is frequently the case. Over one- to three-year time frames, momentum, narrative, liquidity, and cyclical conditions have a much greater impact on performance than long-term valuation parameters. Nonetheless, when “cheap” markets on a CAPE basis show short-term outperformance (one year or less), investors should take note, as the combination of value and momentum is compelling.

Looking ahead, Chile, Colombia, Peru, and the Philippines may be well-positioned to perform over the next year, as they offer both attractive valuations and positive momentum, and are in the early to middle phases of their business cycles. Chile has the added attraction of an upcoming election, which may result in a more business-friendly administration. However, rising geopolitical tensions and sluggish global growth create an unfavorable investment environment. A continuation of U.S. dollar weakness could result in sustained capital outflows from U.S. assets, which would be beneficial for EM stocks.

 

 

Recovering America’s Control Over Naval Logistics: The Case of ZPMC

For decades, U.S. corporations have offshored manufacturing to take advantage of cheap labor, government subsidies, and lax environmental regulations, enabling them to build global value chains that maximized profits. Concurrently, China—through strategic planning and government support—methodically achieved global supremacy in a wide variety of manufacturing industries of strategic economic and military importance. Today, as the two countries find themselves in a “cold war” relationship, U.S. dependence on China for critical imports has caused alarm in Washington. The collapse of the port crane industry is illustrative of how the U.S. ceded a major strategic industry to China—and now deeply regrets it.

 

The United States emerged from World War II as the undisputed global manufacturing hegemon, particularly in military equipment and logistics. In the case of shipbuilding and port cranes, the U.S. maintained its dominance through the 1970s. However, in the 1980s, “Reaganomics” and its aversion to government intervention to support “inefficient” U.S. firms took hold. In 1981, President Reagan terminated construction differential subsidies (CDS) for the U.S. shipbuilding industry—measures that had enabled American shipyards to compete with foreign counterparts. The consequences were stark: by the end of the decade, the U.S. commercial shipbuilding sector had virtually collapsed. Heavily subsidized competition from Japan in the 1970s, South Korea in the 1980s, and China starting in the 1990s undermined the economics of shipbuilding in the U.S. Today, these Asian nations collectively dominate the global shipbuilding landscape, accounting for over 90–95% of new commercial vessel construction. In contrast, the U.S. share of the global commercial market hovers around 0.1%. Without the network effects, scale economies, and skill-building capacity provided by a robust commercial shipbuilding base, U.S. military naval shipbuilding capability has also been severely compromised.

A similar decline occurred in the port crane manufacturing sector—a key component of transportation logistics with significant military relevance. U.S. firms dominated port crane technology and markets throughout the postwar decades, but by the early 1980s they were facing strong competitive pressure from Japanese and Korean firms. One by one, American companies either went out of business or were absorbed by foreign competitors, so that by the early 1990s, the industry was controlled by Asian firms.

The Chinese firm Shanghai Zhenhua Heavy Industries Company (ZPMC), established in 1992 with an aggressive international focus, quickly won contracts with major ports including Vancouver, Oakland, Miami, Houston, Long Beach, and Los Angeles. By the mid-2000s, ZPMC had secured over half of the global market for quay ship-to-shore cranes. Over the past twenty years, ZPMC has captured more than 70% of the global market and 80% of the U.S. market. Including other Chinese port crane manufacturers, China’s global market share is estimated at approximately 80%, with the remainder held by Japanese, Korean, and a few highly specialized European firms.

 

ZPMC is a formidable global competitor and has only grown stronger as it has achieved greater scale and technological expertise. It routinely outbids competitors on price, delivery time, and customization—often pricing at less than half the cost of rivals and offering significantly faster delivery.

 

ZPMC is a major state-owned enterprise in China, directly overseen by the Assets Supervision and Administration Commission (SASAC). Numerous U.S. officials, intelligence agencies, and congressional committees have expressed serious concerns about ZPMC’s ties to the Chinese military.

 

The company benefits from extensive state support. In addition to its close collaboration with the Chinese military, it receives substantial tax breaks, subsidies, and access to cheap credit from government funds and state-owned banks.

 

Despite its commanding market share both globally and within China, ZPMC delivers poor financial performance. Over the past 15 years, revenues have nearly doubled, but earnings have not kept pace. The company has maintained a net profit margin of only around 2%. Its return on equity (ROE), despite a highly leveraged balance sheet, has averaged just 3% over the past nine years—a level of profitability unacceptable to private enterprises in Western markets.

As is common for most state-owned companies listed on Chinese stock exchanges, ZPMC’s stock has languished.

Today, the global port crane industry is dominated by a company that functions as both a ward and an instrument of the Chinese state and is a major beneficiary of comprehensive financial and regulatory support. As the political mood in Washington shifts, the absurdity of this situation has become increasingly apparent. Policymakers are now coming full circle—proposing steep tariffs of up to 100% and financial support for alternative suppliers, similar to those eliminated by Reagan in 1981.

The End of the Global Debt Cycle and the Return of Financial Repression

The world economy has experienced a long debt cycle under the fiat, dollar-centric monetary system in place since 1971. The process of debt accumulation was slowed by the Great Financial Crisis of 2007–2008 but then resumed its upward path, propped up by deflationary forces, Federal Reserve intervention, and financial repression policies. However, recent market trends point to limits to further debt accumulation.

Since President Nixon severed the link between the U.S. dollar and gold in August 1971, the dollar has depreciated by 98% relative to gold and by 87% in purchasing power. Nevertheless, beginning in the late 1970s with the Volcker Fed, a new phase of monetary stability was achieved, and the “great financialization” of the neoliberal revolution began, fueled by a multi-decade-long decline in interest rates.

The chart below, from the IMF’s Global Debt Monitor, shows the evolution of world debt levels in the post–World War II period. From 1950 to 1980, the world debt-to-GDP ratio increased at a tepid pace—from 97% to 108%. From 1980 to 2000, during the heyday of dollar hegemony and monetary stability, global debt ratios soared, reaching 195%. Since 2000, debt levels have continued to rise, though at a slower and more uneven pace, reaching 250% of GDP in 2020.

The Bank for International Settlements (BIS) provides another, more granular, source for global and country debt levels. The BIS’s total world sample for 2001–2024 is shown below. World debt-to-GDP levels peaked near 300% in 2020 and stood at 250% in September 2024.

The chart below shows the persistent rise in the U.S. debt-to-GDP ratio from 1980 to 2011, broken down by government, households, and corporations. Total U.S. debt-to-GDP rose from 130% in 1980 to 255%, while the government’s share increased from 32% to 103%.

Following the GFC, U.S. debt levels stabilized at around 250% of GDP, as private debt from households and corporations was offset by rising government debt. This was a long period marked by deflationary tendencies: first, declining oil and commodity prices; second, a strong dollar; third, an influx of cheap immigrant labor; and last but not least, a flood of imports from Asia, primarily China. This deflationary environment, enhanced by financial repression (negative real interest rates, yield curve control and quantitative easing), facilitated large fiscal deficits. Over the 12-year period from 2011 to August 2023, real annualized rates on 2-year Treasury bonds were low to negative, averaging –1.4%. During the four years of the Biden administration, annual fiscal deficits averaged over 8% of GDP, enabled by persistently negative real rates, which reached as low as –6% in 2022.

As the chart below shows, the world has changed since 2022, when 10-year Treasury yields rose from 1.5% to over 4%. Since August 2023, interest rates have again turned positive on 2-year Treasuries. With the “free lunch” of financial repression over, the rising cost of financing the debt has raised alarms in Washington and financial markets over the sustainability of fiscal deficits. Interest payments on the national debt increased by $251 billion in 2024 to $1.12 trillion—well above defense spending—and are expected to rise further as debt is refinanced at higher rates. Both Fed Chair Jerome Powell and the Congressional Budget Office (CBO) have warned that the U.S. is on an “unsustainable fiscal path.”

The dilemma faced by the United States is shared by several other countries that also benefited from financial repression in recent years but must now adapt to higher interest rates.

For example, the UK successfully reduced its government debt-to-GDP ratio from 140% to 89% between 2021 and 2024. However, its 10-year Treasury borrowing rate has now risen to 4.5%, compared to near zero in 2020.

Japan, the champion of financial repression, has seen its 10-year Treasury yield rise from –0.5% to +1.5% since 2020,  increasing the cost of financing its enormous government debt.

Brazil is another country facing a significant challenge. It enjoyed a period of negative real interest rates in 2020–2022, which helped reduce debt ratios. However, real rates near 10% have returned with a vengeance, and debt is rising again. Fiscal deficits are expected to remain very high in the coming years (in the order of 7–8%, according to IMF forecasts), while GDP growth remains low. Brazil is experiencing “fiscal dominance,” a condition in which monetary policy is constrained by the growing weight of interest expenses on fiscal expenditures. The last time Brazil experienced a surge in debt levels (1998–2002), it was able to reduce them thanks to a fortuitous economic shock brought about by the China-fueled super-commodity cycle (2002–2012). The chart below shows how the combination of strong economic growth, capital inflows, and currency appreciation reduced debt levels during this period. Unfortunately, a repeat of these circumstances is unlikely. It is far more probable that Brazil will have to resort to yield curve control measures and higher inflation to bring debt levels under control.

Turkey is a recent example of a country that has successfully deleveraged through financial repression. The latest IMF Staff Report on Turkey outlines the measures adopted: monetary expansion to inflate prices; suppression of government bond yields to artificially low levels; interest rate caps on loans; mandated holdings of government bonds at below-market rates; limits on offshore swaps; and export surrender requirements (i.e., capital flow management measures). The result of these anti-market policies of financial repression has been a significant reduction in debt ratios, creating the conditions for an eventual new credit cycle.

China stands out for its continued rapid debt accumulation in recent years. While much of the world successfully implemented financial repression policies during the pandemic years, China faced a deflationary environment caused by a collapse in real estate prices and an oversupply of manufactured goods. According to the BIS, the total debt-to-GDP ratio is approaching 300%—a figure that would be considerably higher if Chinese GDP were measured in line with Western standards. China appears to be following the path of Japan—growing government debt and exports to compensate for weak domestic demand—a model that will likely cause rising trade tensions.

The chart below shows BIS debt data on most of the world’s prominent economies.

Countries highlighted in red are those that have accumulated debt quickly to excessive levels, either at the government level or across the entire non-bank sector (government, households, and corporations) and are expected to see further increases in debt-to-GDP ratios over the next five years (according to IMF estimates).

Countries in black may have experienced rapid debt accumulation but still have the capacity to increase debt and are not expected to run large fiscal deficits in the future.

Countries in green have accumulated debt at a moderate pace and still have room to increase debt ratios.

The first two columns show the increase in debt ratios over the past ten years; the next two columns show debt ratio levels as of Q3 2024; and the final column shows IMF estimates of the annual increase in government debt ratios over the next five years.

China, Brazil, Japan, France, and the United States are the countries with the most concerning public sector debt dynamics and are, therefore, the most likely to engage in financial repression.


Mexico, Indonesia, Germany, Poland, and Turkey have sound debt dynamics and are less likely to resort to financial repression.

The United States and the United Kingdom have both successfully used financial repression to stabilize debt ratios. However, they still have high debt levels that are expected to increase in the coming years. As the chart from Lynn Alden (https://www.lynalden.com/) shows, the United States has largely repeated the path it followed between 1920 and 1950. That period was followed by a long phase of high growth and low deficits, which significantly lowered debt ratios. Today, optimists foresee a tech-driven productivity boom that could lead to a similar outcome over the next decade. Pessimists, however, point to poor demographics, disappointing productivity trends over the past twenty years, and rising obligations for defense, healthcare, and social security, all of which suggest a much bleaker outlook.

A New Cycle for International Markets

American stocks have experienced a stratospheric rise since the Great Financial Crisis, while foreign stocks have languished. This long period of “American Exceptionalism” was marked by enormous inflows of foreign capital into the U.S., which boosted the value of the dollar and U.S. assets to altitudinous levels. However, recent political shifts and new market trends point to a tidal change that could lead to a sustained reversion in U.S. asset prices and a relative outperformance of international assets.

In recent American financial history, periods of “American Exceptionalism” have been followed by bouts of “American Malaise.” These cycles—from euphoria to despair and back—are typically marked by the relative GDP growth of the United States compared to the global economy. During periods of American Exceptionalism, strong U.S. GDP growth relative to the global economy is usually driven by political and technological trends. Conversely, during periods of American Malaise, relatively weak U.S. growth is typically driven by a reversion of previous trends and by the rise of foreign economic powers, such as Germany in the 1970s, Japan in the 1980s, and China and emerging markets in the 2000s. Importantly, these cycles have significant effects on monetary flows, currency valuations, and asset prices. During periods of American Exceptionalism, capital is attracted to the United States, driving up the value of the dollar and U.S. asset prices. During periods of American Malaise, capital flows out of the U.S. into foreign markets, driving their currencies and markets higher.

Since the mid-1960s—a period that includes the turbulence of the final years of the Bretton Woods dollar/gold fixed exchange rate system and over five decades of a U.S. dollar-centric fiat currency global monetary system—the U.S. has experienced three full cycles of sentiment, moving from pessimism to exuberance and back. Conveniently, these cycles can be marked by the rise and fall of the dollar in a fiat currency system such as the one we’ve had since 1971. The chart below highlights these four phases:

Cycle 1

American Malaise (1966–1980)
By the mid-1960s, both Europe and Japan had recovered from World War II, and the U.S. began to run current account deficits, leading some countries—such as France—to decry the “exorbitant privilege” enjoyed by the U.S. and to repatriate gold. This led President Nixon to end the convertibility of the dollar to gold in 1971, breaking the Bretton Woods system established in 1944. The collapse of the dollar and the stagflation of the 1970s ensued. This period of American Malaise was marked by the rise of Germany as an economic power and the embrace of the Deutsche Mark and gold as alternative “safe haven” assets. In 1979, President Carter’s famous “Malaise Speech” expressed a general feeling of national frustration and pessimism following Vietnam, Watergate, and the Iranian Revolution. He warned that “the erosion of our confidence in the future is threatening to destroy the social and political fabric of America.”

American Exceptionalism (1979–1986)
President Reagan (1981–89) embodied American Exceptionalism with his “Morning in America” rhetoric and his vision of America as a “shining city on a hill,” a moral lighthouse to inspire the world. An extremely hawkish monetary policy, executed by Fed Chairman Paul Volcker, triggered debt crises in Latin America and Eastern Europe, collapsed commodity prices, and set off huge capital inflows into U.S. assets, driving the dollar upward. The Plaza Accord in 1985 aimed to weaken the dollar through coordinated market intervention. Reagan also restrained Japanese car exports (1981), requiring automakers to build factories in the U.S. to maintain market share.

Cycle 2

American Malaise (1986–1992)
During the second half of the 1980s, Japan was heralded by magazines and best-selling books as the new economic power threatening U.S. hegemony. Japanese companies—such as Toyota, Sony, Panasonic, and Honda—were believed to be outperforming U.S. competition by being more efficient, more innovative, and offering better quality. This aura of Japanese dominance was punctuated by a wave of Japanese acquisitions of Western trophy assets, such as Rockefeller Center, Pebble Beach, and iconic Western artworks. Moreover, this was a period of strong recovery for emerging market economies, which once again attracted significant speculative capital. America’s despondency was further punctuated by the First Gulf War and a rise in oil prices, which drove the U.S. economy into recession and led to the election of President Clinton.

American Exceptionalism (1992–2001)
President Clinton (1993–2001) presided over a remarkable period of American Exceptionalism. The Cold War ended in 1991 with the collapse of the Soviet Union. Francis Fukuyama’s book The End of History (1992) expressed the widely held belief that Western liberal democracy and capitalism had permanently won the battle of ideas. The “peace dividend” allowed Clinton to cut defense spending from 6% of GDP to 3% and, along with tax increases, run fiscal surpluses from 1998 to 2001. The 1990s saw a productivity boom driven by the Information and Communication Technology (ICT) revolution—computers, software, and networking technology—and a stock market boom, particularly in tech and internet companies. Concurrently, emerging markets suffered a long series of financial meltdowns, beginning with Mexico in 1994, Asia in 1997, and Russia in 1998.

Cycle 3

American Malaise (2002–2012)
Clinton’s deregulation of the financial sector (the repeal of Glass-Steagall and deregulation of derivatives) laid the groundwork for the dot-com and housing bubbles, which burst in 2000 and 2007, respectively. The stock market crash and the Great Financial Crisis brought forth unorthodox monetary policies, which undermined the dollar and revived interest in gold. The accession of China to the WTO (2001) and the launch of the euro (2002) also sparked dollar outflows. China’s economic miracle (2000–2012) caused a commodity super-cycle and enormous inflows into emerging market assets, which created massive stock market and credit bubbles.

American Exceptionalism (2012–2024)
The GFC left most of the global economy in a semi-depressed state, including China, which was burdened with excess debt, a housing bubble, and diminishing returns on infrastructure investment. However, starting in 2012, the U.S. experienced a relative resurgence based on four pillars: (1) a rising dollar, (2) the shale oil revolution, (3) the remarkable success of its winner-take-all global tech titans, and (4) a cycle of fiscal expansion and debt accumulation. These factors led to massive inflows of capital into American financial assets and a singular “wealth effect” for  America’s moneyed classes.

Cycle 4

American Malaise (2025–?)
President Trump has articulated a darkly negative vision of a country mutilated by elites—both domestic and foreign—who have “sold out the country” and caused “an American carnage” of crime, poverty, and decaying infrastructure. He aims to dismantle both domestic institutions (public programs, the courts, universities) and the American-led world economic order—its liberal foundations and its system of alliances—which has long buttressed American leadership and soft power. Unsurprisingly, Trump’s wrecking-ball tactics are unsettling investors and raising questions about the reliability of the U.S. as a partner in military, financial, business, and educational matters.

Initial reactions to Trump’s second-term agenda point to the start of a new phase of American Malaise. A weakening dollar, rising long-term interest rates, declining U.S. stock prices, and a surge in the price of gold indicate significant capital outflows from U.S. assets. Moreover, the drivers of the past decade of American Exceptionalism appear tired. First, the administration is ambivalent about the dollar’s reserve status and is considering measures (e.g., a new Plaza Accord) to bring it down from its  high level. Second, the shale revolution appears to have peaked, with output now expected to stabilize. Third, high valuations, saturated markets, deglobalization costs, regulatory hurdles, and increasingly capital-intensive business models for the tech titans point to more moderate return prospects. Fourth, bond markets are showing low tolerance for further fiscal largesse.

A phase of American Malaise can be expected to last 5–10 years. Outflows from U.S. markets into foreign markets drive the dollar lower, raise commodity prices, and unleash credit, boosting GDP growth and asset prices outside the U.S. These flows create a virtuous cycle of rising confidence, growing liquidity, and higher asset prices abroad.

Expected Returns in Emerging Markets Q1 2025

Emerging markets stocks outperformed the S&P 500 in the first quarter of 2025 in a rare show of strength. China and Latin America led the way, while India sputtered.

Foreign markets are buoyed by hopes that a shift is occurring in the relative strength of growth away from the U.S. and in favor of China and Europe. This has led to some dollar weakness and triggered capital flows out of U.S. assets.

The strength of the S&P 500 0ver the past decade can be attributed to two factors: first, a remarkable decade-long expansion in profit margins, of which about 60% was driven by lower interest rates and globalization—two trends that are now clearly in reverse; and second, an expansion of earnings multiples, which has brought valuations to extremely high levels on most measures.

The valuation premium of the S&P 500 over the MSCI EM Index closed the quarter at historically elevated levels, surpassed only by the 2016–2018 and 1998–1999 periods. The rising valuation premium over the past three decades may reflect the U.S. market’s transition from one dominated by capital-intensive cyclical businesses to one dominated by capital-light companies with persistent and rising monopolistic profits. Unfortunately, this transition has not taken place in emerging markets, except briefly in China—until Chairman Xi curtailed the tech sector to “safeguard social harmony.” However, the valuation premium may have peaked and started to trend downward, as America’s tech titans have reached very high valuations and may face lower profitability in the future as they invest heavily in developing the highly capital-intensive and competitive AI business.

The extraordinary profitability of America’s tech giants over the past decade drove profit margins and earnings to record levels. Meanwhile, many other companies in the U.S. and abroad have experienced a prolonged downturn. For example, as shown below, MSCI EM earnings in nominal dollar terms have not risen for about 15 years.

The chart below estimates the current expected returns for emerging markets and the S&P 500 based on a CAPE ratio analysis. The Cyclically Adjusted Price-Earnings (CAPE) ratio, which calculates the average of inflation-adjusted earnings over the past ten years, helps smooth out earnings cyclicality. This tool is especially useful for highly cyclical assets like emerging market stocks and has a long history of use among investors, gaining popularity more recently through the work of Professor Robert Shiller at Yale University. We use dollarized data to account for currency trends, and the seven-year expected returns are calculated assuming each country’s CAPE ratio will revert to its historical average over time. Earnings are adjusted based on each country’s position in the business cycle and are assumed to grow in line with nominal GDP projections from the IMF’s World Economic Outlook (October 2024).

As logic dictates, countries with “cheap” CAPE ratios below their historical average tend to have higher expected returns than those with CAPE ratios above their historical average. These expected returns are based on two key assumptions: first, that the current CAPE levels relative to historical averages are unjustified; and second, that over time, market forces will correct the discrepancy. Historical data strongly supports the second assumption over seven- to ten-year periods, though not in the short term (one to three years). The model may give a false signal if a country’s historical CAPE average is out of sync with its current growth prospects. For example, one could argue that Chile’s current growth prospects do not justify its historically high CAPE ratios. The same may be true for the Philippines.

The following chart shows actual MSCI EM country returns for the past 12 months in the context of which markets had the highest seven-year expected returns at year-end 2023.  The chart shows that the CAPE ratio was not predictive of performance over this one-year period, as is frequently the case. Over one- to three-year time frames, momentum, narrative, liquidity, and cyclical conditions have a much greater impact on performance than long-term valuation parameters. Nonetheless, when “cheap” markets on a CAPE basis exhibit short-term outperformance (one year or less), investors should take note, as the combination of value and momentum is compelling.

Looking ahead, Chile and Colombia may be well-positioned to perform over the next year, as they offer both cheap valuations and momentum and are in the early to middle phases of their business cycles. Chile has the added attraction of an upcoming election, which may bring in a more business-friendly administration. However, rising geopolitical tensions and sluggish global growth create an unfavorable investment environment. Only a continued weakening of the U.S. dollar could result in sustained capital outflows from U.S. assets, which would be beneficial for EM stocks.

The Big Mac Index and the Coming Currency Realignment

In a previous blog (link), we noted the remarkable strengthening of the U.S. dollar over the past 14 years, as shown in the chart below. This long dollar bull cycle has brought the U.S. currency to its highest level of valuation relative to the currencies of trading partners since President Nixon severed the dollar’s link to gold in 1971.

Another interesting measure of relative currency values is The Big Mac Index from The Economist magazine. The BMI compares the dollar price of a Big Mac sandwich in approximately 50 countries worldwide relative to its price in the United States. It serves as an alternative measure of the relative cost of living, incorporating inputs from the agricultural, manufacturing, and service sectors, including taxes and regulations.

The chart below illustrates the change in the price of a Big Mac from 2000 to 2025. In the United States, the price of a Big Mac rose by 130% during this period—significantly more than the 90% increase in the U.S. Consumer Price Index (CPI). The chart highlights striking variations in Big Mac price changes, ranging from a 300% increase in Poland to nearly no increase in Japan and Taiwan.

In accordance with the Real Effective Exchange Rate (REER), The Big Mac Index indicates a strong relative appreciation of the U.S. dollar since 2010. The rankings of the index for the past 25 years for a selection of emerging markets (EM) and developed countries are shown in the table below. The table is color-coded: developed countries in black, EM commodity producers in red, and the remaining EM countries in green. This period spans an extraordinarily turbulent economic environment, including the China “Shock,” the commodity super-cycle, the Great Financial Crisis, the COVID-19 shock, and the beginning of deglobalization. The last 15 years can be characterized as a period of “American Exceptionalism,” driven by the shale revolution and the global dominance of Silicon Valley’s tech titans.

The table highlights several trends over this period, best observed through the color-coded categories:

  1. Developed Countries: These economies have maintained a relatively narrow range of currency values relative to each other. Although the U.S. dollar is currently at a high level, it has typically remained in the top third of the table. The Scandinavian countries, Britain, and Switzerland have stayed within a stable range near the top. Even Canada and Australia—both major commodity producers—have remained within a relatively tight range, as have Hong Kong and Singapore, two service-driven economies at the core of global trade. A notable exception in the developed world is Japan, which has experienced an extraordinary devaluation of the yen due to chronic deflation, quantitative easing, and external economic shocks. However, recent yen strength and pressure from the Trump administration may indicate that this trend is beginning to reverse.

  2. Emerging Markets (Excluding Commodity-Dependent Countries): These countries can be divided into two groups:

    • Mercantilist Economies: Taiwan, South Korea, China, Thailand, Malaysia, and Vietnam have prioritized export competitiveness, leading to remarkable stability in the index, positioning them consistently in the bottom third. These nations have been among the biggest beneficiaries of hyper-globalization but now stand to lose from deglobalization. The cases of South Korea and Taiwan are particularly striking—despite their increasing wealth, their currencies have become more competitive in terms of the BMI. Given their strategic alliances with the U.S., strong pressure from the Trump administration regarding tariffs and currency realignment is expected. All these countries find themselves caught between the U.S. and China, facing the dual challenge of Chinese export competition and the threat of U.S. tariffs.
    • Domestic Market-Oriented Economies: Countries such as Turkey, Poland, India, and the Philippines show little commitment to currency stability, experiencing broad exchange rate fluctuations that undermine their export competitiveness.

  3. Commodity-Dependent Emerging Markets: These nations experience high levels of currency and economic instability. Over the past 25 years, free capital flows have exacerbated commodity-driven currency cycles, leading to extreme volatility due to “hot money” inflows and capital flight. This instability has contributed to acute deindustrialization in many of these economies. Argentina’s recent experience is particularly revealing—since 2020, the cost of a Big Mac in Argentina has surged by 143%, making it the second most expensive in the world. In contrast, in 2010, Argentina had the second cheapest Big Mac, surpassed only by China. Similarly, Brazil had one of the world’s most expensive Big Macs in both 2010 and 2015, exceeding even traditionally costly countries such as Sweden and Denmark. Among commodity-linked currencies, Indonesia stands out as an exception, behaving more like an “Asian Tiger” currency with relatively low volatility.

In the current landscape of trade wars, shifting economic alliances, and increasing geopolitical tensions, currency realignment is becoming an essential tool for policymakers. The trends highlighted by The Big Mac Index and the Real Effective Exchange Rate (REER) reflect deeper structural shifts in the global economy—from the rise of American exceptionalism to the challenges faced by both developed and emerging markets. As the forces of deglobalization take hold, nations will likely respond with a mix of tariffs, industrial policies, and monetary interventions to maintain competitiveness. The coming years will test the resilience of global currencies, determining which economies can adapt to this new era of economic realignment and which may struggle to keep pace.

America First and Currency Wars

A month into the second coming of Donald Trump, the world is grappling with the meaning of his obsession with trade tariffs. Though it is highly unclear what the details of trade policy will be, it appears the primary objective may be to force global firms to reshore manufacturing to the United States. Policymakers, such as Treasury Secretary Scott Bessent, are talking about a “great economic restructuring,” leading analysts to speculate on possible international agreements to secure investments and bring down the value of the dollar, as was successfully achieved during the Reagan Administration in the 1980s.

The strength of the U.S. dollar is a problem for a government determined to bring back the mercantilist policies of the late 19th century in America. As the chart below shows, the Real Effective Exchange Rate (REER) for the USD is at an extraordinarily high level, well beyond previous peaks in 1960, 1970, 1984, and 2002.

Periods of dollar weakness are associated with strong international growth relative to U.S. growth and a spell of “American malaise,” while periods of dollar strength are linked to stronger U.S. growth and phases of “American exceptionalism.” The dollar has been appreciating since early 2011 in a remarkable occurrence of American exceptionalism, driven by a relatively strong recovery from the Great Financial Crisis, the shale oil and gas revolution, and the phenomenal success of America’s tech titans. Over the past decade, the dollar has also been buttressed by enormous capital flows into U.S. assets, which originate both from institutional investors seeking high returns and from capital flight from emerging markets.

It is unclear how dollar weakness could be engineered by the Trump Administration, as “America First” strategies would tend to favor U.S. growth at the expense of foreign partners and could lead to large investment inflows. Moreover, the chaos created by Trump’s disruptive nature may increase geopolitical risk and further encourage capital flight into U.S. assets.

We can speculate on which countries may be targeted by Trump for retributive attacks. The chart below shows the REERs of America’s main trading partners and emerging markets in terms of the current REER relative to the median of the past 32 years. Japan stands out as an outlier and as an easy target for forced currency appreciation. Europe, Mexico, and the Asian tigers (Korea, Taiwan, and Malaysia) also could be singled out. The circumstances of most emerging markets (Chile, Brazil, Nigeria, etc.) are very different, as currency weakness is not engineered to sustain export competitiveness but rather caused by low growth and capital flight.

 

 

 

Quo Vadis, Brazil? Opportunities and Challenges in The New World Order

The vast majority of Brazil’s population has no recollection of the “miracle economy” years (1968–1973), when the country was a rising industrial power and the star of the developing world. After over 40 years of suppressed ambition, economic stagnation and mediocrity have become the accepted norm in Brazil. With the important exception of agroindustry, where Brazil has maintained world-class status, the country has become an unproductive service economy with poor prospects for growth.

The post-World War II evolution of Brazil’s economy can be divided into two periods. The first, from 1950 to 1980, saw Brazil—aligned with foreign and domestic capital—dominate the mass production technology paradigm. This led to rapid industrialization and the emergence of an urban middle class. During this period, the economy diversified away from commodity exports. The second period, from 1980 to the present, has been characterized by rapid deindustrialization and a return to a level of dependence on commodity exports last seen in the early 1950s.

By 1980, Brazil had largely exhausted the growth potential of mass production technologies unless capital could be reinvested to either support a growing domestic market or access export markets, neither of which occurred. Around the same time, revolutionary advances in transportation (container ships) and ICT (Information and Communication Technology) triggered the migration of Western capital to Asia, where companies sought to exploit cheap labor for outsourcing activities. Since 1980, the Asian Tigers, including China, have followed Brazil’s earlier path and fully dominated the mass production technology paradigm.

Weakened by political, economic, and financial instability, Brazil was unable to respond to the Asian threat in the 1980s. The debt crisis of the early 1980s severely discredited the industrial planning mechanisms used by the Military Regime (1964–1985), but no consensus emerged for a replacement.

As the world embraced the Washington Consensus, promoting the liberalization of capital, goods, and labor flows, Brazil rejected trade liberalization but embraced the deregulation of capital accounts. This made the economy more vulnerable to speculative “hot money” financial flows and capital flight, creating a “rentier” elite with little commitment to reinvesting profits in domestic productive assets.

The great commodity boom (2002–2012), driven by China’s aggressive infrastructure expansion, led to a surge in liquidity for Brazil’s commodity-dependent economy, along with credit expansion, currency appreciation, and increased fiscal largesse. Meanwhile, in 2005, Petrobras announced the discovery of the massive pre-salt offshore oil fields, transforming Brazil from a large oil importer into the world’s seventh-largest oil producer (as of 2024). However, the “commodity curse” hit Brazil hard after 2012, leaving both its manufacturing sector and institutions severely weakened.

Over the past forty years, Brazil has undergone a remarkable transition from a dynamic industrial economy to a low-growth, unproductive service economy. From 1950 to 1980, Brazil’s GDP grew at an impressive 7.1% per year, one of the highest rates in the world. Since then, GDP growth has slowed to a meager 2.1% per year. This transformation is evident when analyzing the contribution of factors of production—labor, capital, and total factor productivity (TFP)—to overall annual growth. The following chart, based on Conference Board data in ten-year rolling periods, highlights the collapse of TFP as the economy has deindustrialized and become dominated by low-value-added services and commodities. Simultaneously, the contributions of both capital and labor have declined sharply.

Brazil’s Opportunity in the New World Order

Because Brazil did not benefit significantly from globalization, it has little to lose from its unwinding. A more protectionist global environment, coupled with a renewed emphasis on industrial planning policies, could be advantageous for Brazil. Such a world would favor large-population countries with significant domestic markets.

Additionally, the emerging technological paradigm of AI and robotics is on the verge of eliminating the labor cost advantages that drove the outsourcing of manufacturing and IT services to Asia. A well-designed approach to industrial planning, combined with the strategic adoption of new technologies, could potentially revive Brazil’s manufacturing sector and drive a surge in productivity growth.

If Brazil could simultaneously expand its domestic market, its chances of success would greatly improve. Today, with a population of 220 million, Brazil’s market opportunity is no larger than that of the Netherlands. However, this market could easily double in size if wealth distribution were made more equitable, as seen during the Plano Cruzado of the 1980s and the commodity boom of the 2000s.

Brazil’s Considerable Headwinds

Unfortunately, the Brazilian opportunity faces considerable headwinds.

  1. Low-Value-Added Economy: Brazil is increasingly a low-value-added service economy highly dependent on commodities, a trend that will be difficult to reverse. A key indicator of development, the value-added content of exports (measured by MIT’s Economic Complexity Index, or ECI), highlights this decline. In 1995, Brazil ranked 24th in the world—alongside South Korea, a leader in emerging markets. By 2022, Brazil had fallen to 49th, lagging behind many emerging markets. Even in service sectors where Brazil has natural advantages, such as foreign tourism, it ranks only 40th globally—far behind Turkey, Mexico, Thailand, and the Dominican Republic.
  2. Declining Productivity and Investment: Falling productivity, low investment levels, and the end of Brazil’s demographic dividend have reduced potential GDP growth to below 2%. As shown in the chart above, productivity, labor quantity and investments are all heading in the wrong direction.
  3. Increasing Dependence on China: Brazil’s growing reliance on China—both as a buyer of its commodities and as the primary source of its manufactured imports—coupled with its geostrategic alignment with China through BRICS, is likely to create tensions with the Trump Administration, increasing risks for investors.
  4. Regulatory and Political Challenges: Brazil’s complex legal, regulatory, and tax systems stifle entrepreneurship, while dysfunctional politics make meaningful reform unlikely. There is no clear consensus on the need for intelligent industrial planning, and recent policy experiments have been poorly designed and wasteful.
  5. Chronic Deficits and Rising Debt: Persistent fiscal deficits have pushed Brazil’s gross government debt to 90% of GDP, with a trajectory toward 100% in the near future. Extremely high real interest rates set by the Central Bank exacerbate the debt burden and contribute to wealth concentration. Some form of financial repression will likely be necessary to manage debt levels, prompting investors to shift capital into dollar-denominated assets.
  6. Capital Flight and Brain Drain: Brazil’s highly sophisticated and cosmopolitan elite is increasingly detached from domestic issues, preferring to invest and reside in Europe and America. Brazilians are reliving Argentina’s 1980s experience, liquidating domestic assets and minimizing their exposure to local policies. Furthermore, cryptocurrency technologies are making capital flight easier than ever.

Given Brazil’s challenges, the return to a growth path that can provide better lives for its population will not be easy. Consensus and shared sacrifices are necessary to effect change, something very difficult to achieve in a highly heterogeneous and fragmented society.

 

China’s Infrastructure Dead-End

China’s economy grew by 5% in 2024, which was exactly the target announced by the government at the beginning of the year. The 2025 target will be announced at the annual Two Sessions conference in March and, no doubt, confirmed at the start of 2026. Though these growth numbers are dutifully parroted by the IMF and the World Bank, they cannot be compared to the GDP data provided by most countries. While GDP is normally calculated post facto based on measures of output, in China it is presented ex ante as political guidance for economic agents, most importantly banks and local governments. In China, this is made possible by the overwhelming power of the central government and the Communist Party. Since the end of China’s Economic Miracle (1986–2010), this system has become increasingly divorced from market reality because resource allocation has been made more challenging by declining productivity growth and worsening returns on capital investments.

China’s post-miracle growth since 2010 has been accompanied by an enormous increase in debt levels. As shown in the chart below, China’s debt-to-GDP ratio has nearly doubled since 2010, mostly to fund infrastructure projects with rapidly declining returns. The current ratio reported by the Bank for International Settlements (BIS) is probably significantly understated because China’s GDP has been arguably overstated over the past decade by some 20–30%.

Large infrastructure investments made in China decades ago led to enormous increases in productivity, which enabled China’s “economic miracle.” On one of my first visits to China in 2000, I drove on a newly built 100-mile highway linking Shanghai to Hangzhou. It was an eerie experience: the road was entirely deserted. Today, this is one of the busiest highways in the world. That same visit, a train ride the 650 miles from Shanghai to Beijing took 16 hours. Today, 240,000 people every day make the same trip by bullet train in about four hours. That same year, Shanghai had three bridges crossing the Huangpu River, which divides the city. Today, there are 24 structures crossing the Huangpu, providing Shanghai with world-class infrastructure on par with Paris, London, or New York- cities that built most of their infrastructure by the 1930s. :

This kind of highly productive investment in infrastructure took place all over China from the mid-1990s until around 2010, accompanied by the greatest process of urbanization the world has ever seen. These kinds of investments are one-time effort that cannot be replicated. Over the past decade, quality infrastructure projects have become scarce, but that doesn’t stop politicians from churning out more highways and bullet trains with dubious utility.

Below, we review a few examples that characterize the nature of infrastructure spending in China today, many of which are trophy projects driven by politicians and the enormous construction/engineering lobby.

High-Speed Rail Expansion

China State Railway (CSR) has ambitious plans to expand its high-speed rail network from 30,000 miles today to 37,500 in 2030 and 45,000 in 2035, mostly into sparsely populated regions. To put this into context, the rest of the world has 9,200 miles of high-speed rail (almost entirely in Europe and Japan), and current plans are for an additional 800 miles by the end of the decade. CSR has spent $500 billion over the past five years and accumulated one trillion dollars in debt. Returns on investment have plummeted, amid reports of empty trains and stations.

Airports, Dalian Jinzhouwan International Airport

China increased airport capacity by 45% over the past five years. The latest five-year plan (2026–30) calls for 140 new airports, to be located mainly in China’s sparsely populated Central and Western regions. Located off the coast of Dalian in Liaoning province, the Dalian Jinzhouwan International Airport is being constructed on a 21-square-kilometer artificial island, making it the world’s largest offshore airport upon completion. The project includes four runways and a terminal designed to handle up to 80 million passengers annually. Dalian is a moderate-sized provincial city with a population of 5.5 million, which already has an airport with a capacity of 20 million passengers annually.

Eco-Cities Initiatives

The Xiong’an New Area is an enormous urbanization project sponsored by Xi Jinping that showcases “Xi Jinping Thought” concepts, such as “ultimate Chinese modernization” and “high-quality productive forces.” The aim is to build a green, highly livable, and innovative “city of the future” with a “noble character and artistic temperament.” $200 billion will have been invested in Xiong’an by 2027, not including the expense of expropriating 124 square miles of prime farmland 60 miles south of Beijing. The city is a creation of bureaucratic urban planning with minimal participation of private interests. Though many government agencies are being forced to move to Xiong’an, their employees may not follow to what is characterized as a “ghost town.”

Solar

China is building a vast ‘Solar Great Wall’ that will power Beijing with green energy. Located in the Kubuqi Desert in Inner Mongolia, known as the Sea of Death, the project, expected to be finished in 2030, will be 400 kilometers (250 miles) long and 5 kilometers (3 miles) wide, and achieve a maximum generating capacity of 100 gigawatts, enough to meet the energy needs of Beijing. This project alone would represent 70% of the current capacity of the U.S. The project may be a godsend for China’s beleaguered solar panel manufacturers, which, incentivized by government subsidies, have invested $50 billion from 2011 to 2022 to bring capacity to 1,200 gigawatts, double total global demand in 2024.

4Q 2024 Expected Returns for Emerging Markets

 

Emerging markets underperformed the S&P 500 in 2024, extending a long losing streak. This marks the seventh consecutive year of underperformance and the thirteenth in the last fifteen years. Only Taiwan and Argentina (actually in the Frontier Market Index) managed to outperform the S&P 500 .

The U.S. market appears to be experiencing a blow-off rally, fueled by a broad consensus on an immaculate soft landing for the U.S. economy and optimism about AI-driven productivity growth. The U.S. market is also benefiting from a remarkable expansion in profit margins, driven almost exclusively by the “Magnificent Seven” technology giants, which is reflected in high expectations for earnings growth in 2025.

The strength of the S&P 500 can be attributed to two factors: first, a remarkable decade-long expansion in profit margins, of which about 60% was caused by lower interest rates and globalization, two trends that are now clearly in reverse; and second, an expansion of earnings multiples, which has brought valuations to extremely high levels on most measures.

The valuation premium of the S&P 500 over the MSCI EM Index closed the year at high levels, surpassed only by the 2016–2018 and 1998–1999 periods. The rising valuation premium over the past three decades may reflect the U.S. market’s transition from one dominated by capital-intensive cyclical businesses to one dominated by capital-light companies with persistent and rising monopolistic profits. Unfortunately, this transition has not taken place in emerging markets, except for a while in China until Chairman Xi squashed the tech sector to “safeguard social harmony.”

Earnings growth has been the main driver of the S&P 500’s outperformance relative to emerging markets over the past ten years, as shown below. From the inception of the MSCI EM Index in 1986 until 2014, earnings growth was similar in both markets, but a dramatic split occurred from that point on. While emerging markets have been in a prolonged earnings slump, S&P 500 earnings have surged since 2014, largely due to the spectacular margin expansion of the tech giants. Although the strong dollar has contributed, it accounts for only about 20% of the relative outperformance. Thus, the key question for investors is: How much longer can the “Mag 7” phenomenon continue?

The chart below estimates the current expected returns for emerging markets and the S&P 500, based on a CAPE ratio analysis. The Cyclically Adjusted Price-Earnings (CAPE) ratio, which calculates the average of inflation-adjusted earnings over the past ten years, helps smooth out earnings cyclicality. This tool is especially useful for highly cyclical assets like emerging market stocks and has a long history of use among investors, gaining popularity more recently through the work of Professor Robert Shiller at Yale University. We use dollarized data to account for currency trends, and the seven-year expected returns are calculated assuming each country’s CAPE ratio will revert to its historical average over time. Earnings are adjusted according to each country’s position in the business cycle and are assumed to grow in line with nominal GDP projections from the IMF’s World Economic Outlook (October 2024).

As logic dictates, countries with “cheap” CAPE ratios below their historical average tend to have higher expected returns than those with CAPE ratios above their historical average. These expected returns are based on two key assumptions: first, that the current CAPE levels relative to historical averages are unjustified; and second, that over time market forces will correct the discrepancy. Historical data strongly supports the second assumption over seven- to ten-year periods, though not in the short term (one to three years). The model may give a false signal if a country’s historical CAPE average is out of sync with its current growth prospects. For example, one could argue that Chile’s current growth prospects do not justify its historically high CAPE ratios. The same may be true for the Philippines.

The following chart shows country returns for 2024 in relation to which markets had the highest 7-year expected returns at year-end 2023. Of the markets with high long-term expected returns, only Peru and Turkey currently have good momentum characteristics. The chart shows that the CAPE ratio was not predictive of performance returns over this period, as is frequently the case. Over one to three-year time frames, momentum, narrative, liquidity, and cyclical conditions have a much greater impact on performance than long-term valuation parameters. Nonetheless, when “cheap” markets on a CAPE basis exhibit short-term outperformance (one year or less), investors should take note, as the combination of value and momentum is compelling.

Looking ahead, Peru and Turkey may be well-positioned to perform over the next year, as they offer both cheap valuations and momentum and are in the early to middle phases of their business cycles. However, rising geopolitical tensions and sluggish global growth create an unfavorable investment environment. As always, a strengthening dollar indicates the need to remain focused on dollar-denominated quality assets.

 

 

3Q2024, Expected Returns for Emerging Markets

Emerging market stocks outperformed the S&P 500 during the third quarter, primarily due to new promises of economic stimulus from China’s government. However, emerging markets underperformed the S&P 500 during the first nine months of 2024, extending a long losing streak. This marks the seventh consecutive year of underperformance by emerging markets and the tenth in the last eleven years. The recent outperformance of emerging markets, driven by a surge in Chinese stocks, has brought the S&P 500’s valuation premium down to more reasonable levels.

The U.S. market appears to be experiencing a blow-off rally, fueled by a broad consensus on an immaculate soft landing for the U.S. economy and optimism about AI-driven productivity growth. The U.S. market is also benefiting from a remarkable resurgence in profit margins, driven almost exclusively by the “Magnificent Seven” technology giants.

The strength of the S&P 500 can be attributed to both multiple expansion and earnings growth. The recent outperformance of emerging markets, driven by a surge in Chinese stocks, has brought the S&P 500’s valuation premium down to more reasonable levels, but it remains elevated though well below in 2000 or 2015—the last two opportunities to generate extraordinary relative returns in emerging markets. The rising valuation premium over the past three decades reflects the U.S. market’s transition from one dominated by capital-intensive cyclical businesses to one dominated by capital-light companies with persistent and rising monopolistic profits.

Earnings growth has been the main driver of the S&P 500’s outperformance relative to emerging markets over the past ten years, as shown below. While emerging markets have been in a prolonged earnings slump, S&P 500 earnings have surged since 2014, largely due to the spectacular margin expansion of the tech giants. Although the strong dollar has contributed, it accounts for only about 20% of the relative outperformance. Thus, the key question for investors is: How much longer can the “Mag 7” phenomenon continue?

The chart below estimates the current expected returns for emerging markets and the S&P 500, based on a CAPE ratio analysis. The Cyclically Adjusted Price-Earnings (CAPE) ratio, which calculates the average of inflation-adjusted earnings over the past ten years, helps to smooth out earnings cyclicality. This tool is especially useful for highly cyclical assets like emerging market stocks and has a long history of use among investors, gaining popularity through the work of Professor Robert Shiller at Yale University. We use dollarized data to account for currency trends, and the seven-year expected returns are calculated assuming each country’s CAPE ratio will revert to its historical average over time. Earnings are adjusted according to each country’s position in the business cycle and are assumed to grow in line with nominal GDP projections from the IMF’s World Economic Outlook (April 2024).

As expected, countries with “cheap” CAPE ratios below their historical average tend to have higher expected returns than those with CAPE ratios above their historical average. These expected returns are based on two key assumptions: first, that the current CAPE levels relative to historical averages are unjustified; and second, that market forces will correct the discrepancy. Historical data strongly supports the second assumption over seven- to ten-year periods, though not in the short term (one to three years). The model may give a false signal if a country’s historical CAPE average is out of sync with its growth prospects. For example, one could argue that Chile’s current growth prospects do not justify its historically high CAPE ratios.

Nonetheless, when “cheap” markets on a CAPE basis exhibit short-term outperformance (one year or less), investors should take note, as the combination of value and momentum is compelling. As shown in the chart below, the current environment does not support using CAPE as a timing tool for investment. Over the past twelve months, investing in the “cheapest markets” (on the left side of the chart) has yielded mixed results, working well for Colombia and Turkey but not for Brazil or Chile. Meanwhile, expensive markets (on the right side of the chart), such as the U.S., India, Thailand, and Malaysia, have delivered stellar results. This suggests that, for now, liquidity—not value—is driving performance.

Looking ahead, Colombia, Peru, and the Philippines appear well-positioned to perform, as they offer both cheap valuations and momentum and are in the early to middle phases of their business cycles. However, rising geopolitical tensions and sluggish global growth create a less favorable investment environment. As always, a strengthening dollar indicates the need to remain invested in dollar-denominated quality assets.

Emerging Market Miracles are Few and Fleeting

Much of the excitement that investors have for emerging markets is anchored in the idea that developing countries grow faster than the sclerotic rich countries of the West and that this growth brings opportunities for extraordinary portfolio returns. Unfortunately, this is largely wishful thinking, as the evidence shows that countries in the developing world have experienced mediocre growth. Nevertheless, there have been important exceptions. A select group of countries have achieved periods of “miracle growth,” allowing them to significantly reduce the income gap with rich countries.

Developing countries, including many key emerging markets, have grown at a slower rate than the bellwether economy of the United States since 1980. This period includes the entire modern era of emerging market institutional investing, which can be considered to have started in the mid-1980s with the launch of the IFC and MSCI indices. It covers the entire era of the “Washington Consensus” for free trade and capital movements, which theoretically should have favored developing countries, and also coincides with a significant decline in the rate of growth of the American economy. The data from the World Bank on GDP per capita growth in dollar terms from 1980-2023 is shown below. About two-thirds of countries have grown at a slower rate than the United States. In emerging markets, these laggards include most of Latin America and Africa—countries which, with the exception of Mexico, failed to participate in the globalization trend. On the other hand, the “convergers,” with the exception of India and Egypt, are all countries that deeply benefited from expanding global trade.

Of the convergers listed above, few achieved impressive growth levels; Turkey, Bangladesh, Egypt, Chile, Indonesia, Malaysia, and India all grew GDP per capita by less than 3% per year. Very few countries are achieving the kind of “miraculous” growth that can be transformational over a generation.

The chart below highlights the few countries that have aspired to “miracle” growth status. True economic “miracle” growth stories have been exceptionally rare in the past 60 years. Only five countries—Singapore, Taiwan, South Korea, and China—have achieved the high GDP growth over extended periods necessary to make giant leaps in the rankings of the wealth of nations. This group of countries, the so-called Asian Tigers, all pursued similar export-oriented mercantilist policies based on the repression of domestic wages and benefited greatly from U.S.-sponsored trade liberalism.

Several countries once labeled “miracles” have been unable to sustain growth. These countries have seen their miracle growth aborted for a variety of reasons related to poor governance and weak institutions. Latin American economies once considered to be on the “miracle” path, such as Brazil and Chile, have fallen into “middle-income traps” characterized by low growth and political and social instability. Brazil, in particular, rejected the globalization trend, doubling down on its reliance on commodity exports. Botswana, once considered the stellar success of Africa, has also slowed.

The integration of Eastern Europe into the rich economies of Western Europe has been an outstanding success, allowing countries like Poland to make significant strides toward convergence, which appears to be sustainable. Poland and other countries of Eastern Europe have benefited from exceptional financial assistance from Western governments and abundant access to private capital made possible by geopolitical and historical considerations.

Most of the miracle economies of the past decades have exhausted the high-growth phase and are now expected to experience mundane to low growth. The chart below shows the IMF’s GDP growth expectations for the remainder of the decade. The new growth hopefuls—Bangladesh, India, Vietnam, and the Philippines—will face more difficult conditions than in the past, as the U.S.-imposed “Washington Consensus” has been replaced by deglobalization and geopolitical conflict.