Month: January 2026

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.