U.S. stocks have definitely taken it on the chin this quarter and no one in the White House appears to care. After all, when was the last time we had a government in any country tell the public that not only were policies going to be followed that will directly create pain in the economy and markets, but that it was perfectly willing to have a recession? While we could talk for hours about the insanity coming out of Washington, a theme has emerged that was not on most radar screens at the start of the year. American exceptionalism, at least in terms of the stock market, has fallen to the wayside.

Canada, the EU and China have wasted no time in retaliating against Trump’s tariffs and are not buying the administration’s use of the “national security” clause in the USMCA agreement that has allowed for these tariffs. First we had fentanyl and now we have Trump and his inexperienced Commerce Secretary trying to convince everyone that the lack of domestic production of steel and aluminum represents a national security issue. I suppose there is no end of examples of national security threats they can bring up. Maybe spray tan lotion? 

In recent weeks, U.S. equity markets have notably underperformed compared to their European and other international counterparts. At the time of writing, the S&P500 had lost more than 10% from its record high only a few weeks ago, leaving the benchmark index down close to 6% since the start of the year. The damage to the NASDAQ has been worse and it has lost roughly 10% so far.  One would think that in this David vs Goliath sparring match, Canadian stocks would be underwater even more, considering the greater sensitivity to trade. Yet, the TSX has lost only a couple of percentage points since the start of the year.

The biggest divergence has been with European stocks and again this is somewhat of a surprise considering the sub-par economic performance delivered by the continent into 2025 and ongoing tensions with respect to Russia and Ukraine. There have also been political divides in Europe, with a surge in popularity among far-right parties, but instead of the policy chaos that is taking place in the U.S., European countries are actually showing unity against common threats. And the two central threats are Russia and U.S. isolationism.

As the chart above shows, there is roughly a 15% performance gap between the S&P500 and the Euro Stoxx 50 index since the start of the year. The gap against the London FTSE is more than 10% and compared with the German DAX, the S&P is underperforming to the tune of close to 20%. It has been a long time since we saw U.S. indices look this week against Europe, but investors have reason to direct capital towards Europe and away from a U.S. environment that oozes uncertainty.

European and Asian economies have implemented significant fiscal stimulus measures to bolster growth amid global uncertainties. Germany, for instance, has undertaken substantial fiscal reforms, including increased defense spending and infrastructure investments, aiming to stimulate domestic demand and economic expansion. Geopolitical developments, particularly the ongoing conflict in Ukraine, have prompted European nations to reassess their defense strategies. Increased defense spending across Europe has stimulated economic activity in related industries, providing a boost to local markets.

This morning, Germany’s newly elected Conservative party reached an agreement in principle with the Greens party to significantly increase the country’s borrowing before a key vote on this issue next week. To say this is remarkable is a massive understatement and underscores the urgency with which European states are addressing not only the need to become more self-sufficient on the military front, but to bolster domestic economic activity as well.

Meanwhile, the U.S. is caught between a rock and a hard place. As much as Trump would like to bring home all the manufacturing, boost the economy, siphon a trillion dollars in tariffs to cover the widening fiscal deficit, policies are pushing the administration further from its goal. If tax cuts are not extended, then there is fiscal latitude for Washington to insulate industries, pay an increasingly heavier debt servicing bill and maintain its defence. Since he has failed to lower prices and improve economic prospects, one would think that the tax cuts have to take priority over tariffs. The problem is that isn’t happening.

The other problem is that, up until lately, the U.S. dollar has appreciated against major currencies, thereby impacting the competitiveness of American exporters. A stronger dollar makes U.S. goods more expensive abroad, potentially reducing export revenues and corporate profits. Now, we talked about the folly of trying to engineer a depreciation in the dollar via the so-called Mar-a-Lago accord that supported European exporters, enhancing their global competitiveness and contributing to the outperformance of European stocks. What we are seeing now, however, in terms of the U.S. dollar vis a vis major currencies like the euro, is that it is it is the relative attractiveness away from the U.S. that is prompting inflows. The chart below shows the euro vis a vis the greenback.  Only two months ago, market participants were talking of a potential nosedive in the euro below parity. Today, we are trading north of US$1.08.

Investor sentiment has shifted towards markets perceived as offering better valuations and growth prospects. European equities, having underperformed U.S. stocks in previous years, now present more attractive valuation levels, drawing investor interest. Additionally, the perception of reduced political risk in Europe, coupled with proactive economic policies, has bolstered confidence in European markets. In contrast, concerns over high valuations in U.S. tech stocks and potential regulatory challenges have dampened investor enthusiasm, contributing to the relative underperformance of U.S. equities.

The recent underperformance of U.S. stocks relative to European and other international markets is a multifaceted phenomenon influenced by trade tensions, fiscal policies, sectoral rotations, geopolitical developments, currency fluctuations, and shifting investor sentiment. We can go back and pick moments in time where the standard rule of investing – maintaining a well-diversified portfolio – may not have worked, like 2022 and even the past two years where U.S. large-caps outperformed. But investing is for the long-term and this rule is the best way to achieve desired risk-adjusted returns over time. The past few weeks have shown us why.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle