Why I don't think America First means Wall Street First

At the start of the year, I highlighted three risks for 2025 - the return of inflation, Donald Trump’s trade policies and the US market’s concentration. I said: ‘navigating these will most likely involve more diversification than has been necessary in recent years.’ My fund picks for the next 12 months consequently included a global fund with an underweight to the US, an income-focused fund with a bias towards Europe, and a US fund with no exposure to the Magnificent Seven.

It is too early in the year to draw conclusions, but don’t let that stop me. January and February have confirmed my hunch that we should temper our optimism with caution and put our eggs in a range of baskets. Over the last three months, the worst-performing major market has indeed been the US, which has moved sideways as the Trump Bump faded. Over the same three months, European shares have risen by 15 per cent, while China has built on last autumn’s stimulus-fuelled rally and Japan has continued to attract the world’s best-known investor. The post-election consensus that ‘America First’ would mean ‘Rest of the World Second’ has, in stock market terms, been wrong.

To avoid accusations of cherry picking, let me confess that my bet on smaller US companies has so far been wrong. The Russell 2000 smaller company index and the equal weighted version of the S&P 500 have done even worse than the US benchmark in the year to date. The glass-half-full view of the Trump tax-cuts and deregulation growth story has been replaced by a broad-based, glass-half-empty narrative of tariffs, inflation, and job cuts.

Things are moving fast, and markets are struggling to keep up. It would not have been unreasonable to view the abandonment of the transatlantic alliance as a negative for Europe. But that is not how investors have read it. They have looked through heightened uncertainty as the Trump administration has replaced unconditional support for Ukraine with a nakedly transactional approach. In the rest of Europe, investors see early signs that post-Brexit mistrust is being set aside as we emerge from the comfort blanket of American security promises to invest in our collective security. For defence companies like Britain’s Bae Systems and Germany’s Rheinmetall, this has been a positive.

Since the US Presidential election in November, Germany’s DAX index has risen by 18 per cent while the S&P 500 has eked out a 1 per cent gain. This is not what you might have expected if you had simply compared America’s robust corporate earnings growth and buoyant labour market with Germany’s political and economic woes as it grappled with the end of cheap energy and subsidised defence.

What mattered more was that America was priced for perfection while Germany had been written off by investors. When sentiment is that extreme, it does not take much for the pendulum to swing back again. In the three months since the election, the US has seen consumer confidence fall, inflation expectations rise, a cooling of the housing market and the first contraction in service sector activity in two years. On the other side of the pond, earnings expectations have ticked up, the end of the war is in sight, the European Central Bank is cutting interest rates and a new two-party coalition in Germany is looking to increase spending, notably on defence.

Rotating away from US markets has paid off in Asia too. China’s return to favour began in September when the government unveiled some promising stimulus measures. The rally accelerated last month when DeepSeek shocked the tech world with a cost-effective alternative to US dominance of artificial intelligence. At the same time, President Xi Jinping has decided that it is OK for entrepreneurs to get rich after a few years in which putting your head above the parapet looked risky. Donald Trump’s early salvos in his nascent trade war have been easy on China.

As with Europe, sentiment has been key. The valuation of the Chinese stock market suggested the country was all but un-investable. It entered the year as one of the world’s cheapest stock markets, even more out of favour than our own in the UK. Like the UK, it traded at barely half the multiple of earnings that American shares still attract. Again, it has taken only a modest re-assessment of the outlook for that valuation gap to narrow.

No-one spots a sentiment opportunity like Warren Buffett, and this week we learned that he is doubling down on his contrarian bet on a third out of favour investment opportunity - Japan. Buffett’s annual letter to shareholders, released last weekend, lit a fire under the shares of Japan’s big five trading houses, companies that he first invested in five years ago. Confirming that the 5 per cent stakes he took then had risen in value from US$14bn to over US$23bn, he said he had agreed with the companies to lift Berkshire Hathaway’s 10 per cent investment cap. He plans to invest more and for his company to hold the stakes for ‘many decades’.

The five trading houses - Marubeni, Mitsubishi, Mitsui, Itochu and Sumitomo - are a diversified play on Japan’s governance reforms, the return of healthy inflation after decades of stagnation, and mutually beneficial links between Japan and the US in the transactional world Donald Trump is creating.

If we have learned anything in the first two months of 2025, it is that the world has become more uncertain since November and the market’s response even more so. In this unpredictable environment, I’m happy to hedge my bets. As Harry Markowitz, the father of modern portfolio theory, said: diversification is the only free lunch in investing.

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Please note that the views expressed in this article are my own.