In this week’s conference call (playback details below), I touched on two key themes that have emerged from Trump’s self-inflicted policy vortex – that equities may not have yet seen a bottom and that the exodus from U.S. securities may just be starting. Wednesday’s tape said it all. After posting only modest losses in the morning session, U.S. stocks tanked, while the Canadian benchmark ended with a small gain and European indexes ended either flat to up slightly. Where analysts were just weeks ago talking about U.S. exceptionalism and how this would fuel American markets to yet loftier highs against a staid international performance, the tables have turned, and I think we are starting to see investors ponder whether their portfolios should have anything except the U.S.

For decades, the world has been content to fund America’s trade and fiscal deficits. Why? The U.S. offered up a large and strong consumer base to purchase what the world had to offer, but American firms that operated abroad also benefited by producing in lower-cost regions and selling at a profit in the U.S. Capital flowed in the states and led to an exceptional growth in equity market valuations, while demand for U.S. debt securities generally kept yields lower than they would have been otherwise, thus lowering the cost of capital for firms and households alike. This exchange allowed the U.S. to become less dependent on trade and more dependent on its own people.

That said, the U.S. is still the third largest in the world in terms of total trade (exports plus imports) representing close to 11% of total global trade, according to the World Trade Organization.  The EU sits on top with close to 13% and China’s share is just under 12%. In a nutshell, Trump’s desire is to further reduce the dependency on trade and become more self-sufficient. The problem is that this is way more easier said than done.

Even for companies that are professing their loyalty to Trumpnonomics and promising to onshore production, the laws of capital market physics would eventually kick in. Shareholders will not be happy with lower margins because of higher labour costs than what were achievable outside of the U.S.  Someone commented this week that firms with an abundance of cash on the balance sheet could eat into that in order to absorb some of the margin compression from higher costs. They might share some of the burden with their suppliers, but aren’t they also producing in the U.S. and facing the same challenges?  The only other option would be to pass on a greater amount on to consumers or implement a robotic labour substitution greater than anything we’ve seen. Unfortunately, robots are not going to be voting in the mid-term elections.

With weaker potential employment growth, despite achieving this mythical state of self-sufficiency, the share of consumption of total real GDP would in fact decline. Consumers would be pressured to pull back on spending because of either job loss or job uncertainty, however, this could coincide with higher prices from cost pass-through. In other words, the share of household budgets going to consumption of goods would likely increase. Americans would become poorer, not wealthier.

To the extent that these fundamentals are reflected in market valuations, a shift in future average equity returns from what historical averages is also possible, meaning that the health of public and private pensions would be in question, not to mention individual retirement accounts (IRAs) and 401Ks. Lower future returns would also have negative implications for financial plans which in turn could prompt U.S. households to rein in spending pre- and post-retirement. This might even cause Americans to look to diversify away from U.S. investments in their domestic portfolios. And this is could potentially compound a global shift in appetite for U.S. securities.

According to U.S. Department of the Treasury’s preliminary report on foreign holdings of U.S. securities, the total value of securities held as of June 2024 was $31.3 trillion, with $17 trillion in U.S. equities, $13 trillion in U.S. long-term debt securities and $1.3 trillion in short-term debt. Overall, this represented an increase of 16% from June 2023, though much of this was due to the increase in equity valuations. Of the total, about $6.6 trillion was held by official (aka central banks) funds. Japan is currently the largest holder of U.S. treasuries, with north of $1.1 trillion and China’s holdings are in excess of $800 billion.

While foreign holdings of U.S. debt were just over 20% last year of total debt outstanding, that is still a significant share. Last week, when the U.S. treasury market was rocked, there was talk that some of the selling pressure stemmed from foreign selling. It’s impossible to ascertain how much, if anything, was attribute to this. China has in fact been whittling down its holdings of treasuries since the start of the first Trump term and they are now down about $400 billion from 2017. Some have suggested that China has reduced its exposure to U.S. debt in preparation for a possible trade row like we find ourselves in now. The logic goes that if one wanted to use their U.S. holdings as leverage, with the potential to liquidate in significant amounts, you would want to limit the price hit your own holdings.

How much foreigners are losing their appetite for U.S. securities is unclear and we will not get the Treasury’s June 2025 survey for quite some time. For now, it is important for investors to maintain a strategy of diversification. That doesn’t mean an exodus from the U.S. investment landscape, but perhaps a trimming back. Going back to comments I have made before, Trump’s wish for a weaker U.S. dollar may come to fruition, even if through the messy channel of foreigners exiting equities and fixed income because of credit and political concerns. Because of that, we are still sticking with hedged approach to exposure south of the border.

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

Andrew Pyle

Market Call Playback details:

Toll-free dial-in number (Canada/US): 1-800-408-3053

Local dial-in number:                           905-694-9451

Recording Passcode:                          653436353#

Recording Expiry Date:                       15-May-2025