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Pushkin.
Big investors have got themselves into a bit of a pickle. For the past few years, in fact, the past few decades, asset managers all over the world have bought more and more and more US stocks. Somehow, we've ended up in a world where the US makes up 25% of the world's economy-ish, but about 70% of the big global stocks indices. Investors have just been treating it like home. Now, obviously, forever, that's been fine. Now,
Now it's a little bit less fine, so the great rotation away from the US is upon us. Today on the show we're asking, what is the new normal? And will Europe manage to snatch defeat from the jaws of success yet again?
You're listening to Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at FT Towers in very chilly London. I'm joined in the studio, unusually, by the FT's very own Ian Smith, a reporter also in London who covers anything and everything to do with markets. And he's here making his Unhedged debut. Ian, welcome. Thank you for having me. Now, you used to have a nice life writing about insurance at the FT. Yeah.
I did. For some stupid reason, you decided to move over to markets from insurance. Are markets driving you round the bend? Well, I seem to have the reverse Midas touch when it comes to the markets, because before I was the insurance correspondent, I was the deputy news editor with you on markets. I joined in 2019, just before the COVID sell-off. And then I had three quiet years on insurance and I've come back. So I think I am the problem. But
But I'm very happy to be doing this and happy that we're doing our own great rotation away from the US to Europe with our all-European cast today. We don't need those guys in New York. You and I spend a large chunk of our life talking to investors, big money managers, right? They run money for insurance companies or for pensions or just investment management, all this stuff. And for me, pretty much every conversation at the moment is like, whoops, what?
We're massively overweight the US and we kind of didn't really intend to do that. And now all of a sudden there's lots of political and economic risk attached to that that wasn't there before. I mean, how much is this coming across in your conversations? Our massively investor confidence from Europe and the US has just been shaken in recent months. And you can view it across US policymaking, tariffing penguins,
You know, the Federal Reserve independence, that coming under question, but also how investors have been burnt by this massive bet that they've made on U.S. equities. Yeah. And in large part, when it comes to stocks, they haven't hedged out the currency risk because in times past, they've benefited. The dollar has strengthened with all these inflows into U.S. assets.
That's added to the returns when they've been translated back into European currencies. But now we have the reverse happening. And if you look at the S&P 500, it's down around 4% in dollar terms this year.
But if you look in euro, that's about 12%. So it's been a massive increase in the pain felt by European investors that has left them, while they are also questioning things like US rule of law, the strength of institutions, they're also saying not hedging this currency risk has really hurt us. Yeah, so there's pain coming from all sorts of different directions, right, if you're a European investor in the States. So first of all, there's just like big tech has rolled over.
A lot of those bets on big tech stocks like Nvidia have not been doing so well past a couple of, well, past few months really.
That kind of makes sense. Something like shoots all the way to the moon. It's going to fall a little bit back down again. And there is this new challenge to US tech from China, at least in some form. Then you've got the Trump factor, the tariffs, the penguins, the whole thing. And as you say, people are worried about stuff like rule of law, which is not a trivial thing to worry about when it comes to thinking about where to put my pension. Thank you very much. I'd like you to think about this sort of thing.
So, yeah, U.S. markets have had a horrible run. Just looking at my little screen here, the S&P 500, the big index of U.S. stocks is down like 4% so far this year, whereas even the FTSE 100 in the U.K. is up 5%.
This doesn't normally happen. And DAX in Germany is up 16. And that's, again, before you get into the currency bit. So let's just unpack that a little bit. As you say, if you are a foreign investor in the US, you generally win because the stocks do great just in and of themselves. And then you have a nice strong dollar. So you get a double whammy.
not happening. And that has been very useful, as you say, in recent times where we've had that bull run in US stocks and the dollar appreciating. It's also helped European investors in worse times where you have the dollar being an offset when we've seen Wall Street stocks fall in previous episodes. That offset is something they've relied on when they construct their portfolios. And that hasn't happened this time. It's the opposite. So that's why it's
Even worse for some of the real money that the institutions... The really big investors, yeah. Yeah, so they're now reappraising...
the dollar as a portfolio offset and how much they can trust that. Plus, as you say, on just the stock market performance, people came into the year very positive about the US, overly optimistic and overly pessimistic about Europe. And what we've had in recent months has been some of the downsides of the US trade policy playing out for the US economically, but also this galvanizing its
effect it's had on Europe, which has made people a lot more positive about European assets. So that's played out at the same time and fed into that Euro strength, which is the other side of that currency dynamic. Yeah, there's a lot going right for Europe, right? I mean, Ukraine is inching towards something that will eventually look something more like peace, which has got to be a good thing, at least a ceasefire. It's coming into view. I don't want to suggest that this is like an imminent thing, but it's coming into view.
But also, and this is something that Rob and I argue about on this podcast a lot, is that there's a rally around the flag thing going on. There's this idea that Europe has got to go it alone on defence and on climate and on lots of other things without the US because it's just not there anymore. And so...
Suddenly you have this idea that not just economically, but politically, it makes sense to put money to work at home. I keep saying to Rob, I think...
American market observers or investors really underestimate how important it is, how deeply offended European asset managers have been by what the new Trump administration has been up to. And, you know, in terms of, you know...
criticizing European free speech or getting involved in elections and kind of boosting the right wing of European politics. This has gone down incredibly badly with European investors. So there has been this big shift, this kind of move to, okay, let's put our money to work at home instead of putting it all in the US. And there's various ways you can look at that, right? And I think that's a really interesting point you make because some of those pension funds, which we know are very slow moving in terms of those decisions, those
will play out over time. But we've already seen some investors are looking at ETFs as a proxy for European investment in the US. It's like exchange-traded funds. Yeah, if you look at these exchange-traded funds, but look at ones that are domiciled in Europe, but invest in US stocks and US bonds, those bonds
funds lost about two and a half billion euros in April, according to Morningstar data, suggesting that European investors were, during that tumult, kind of pulling money out of US stocks and bonds. That's one way of looking at it. Some of the mutual fund data also shows a similar thing. Another way to look at it is through some of the market moves that we've seen. So yes, on this pod and generally on our coverage, we've made a lot of the US dollar fundings
falling at the same time that US government bonds and stocks fell, the sell America moment. But also in April, you had German government bonds rally with the euro, which also typically doesn't happen because government bonds normally sell off on good economic news that lifts currencies. So the fact you've had that suggests in many investors view, there is some kind of capital flight going on from US dollar assets into Europe. And the
The big debate in the market is how far has that gone and how far can it go? Yeah, no, exactly. So you listen to enough podcasts about markets or read enough stuff about markets, you'll hear this distinction between fast money and real money, right? And when people in markets talk about that, by fast money, they mean a little bit of retail, but also hedge funds and, you know, other kind of fast moving money managers, right?
On the other side of the coin, you've got real money, which is pensions and insurance companies as well. These are like enormous pots of money. And they don't just jump up and down and get in and out of markets at the click of a finger. They take months to decide how are we going to change our asset allocation. So...
A lot of the people I speak to are saying what we've seen so far in terms of the ETF flows you were just talking about, in terms of the market performance we've seen so far this year, is the tip of the iceberg because the really big guys have actually not yet moved their allocations around. So...
you know, never make predictions about the future, but it certainly looks like there's going to be a lot more investment money sticking in Europe rather than heading to the US in the months ahead. Yeah, and the point you've made in your recent column, it
It comes from a very high point in terms of the allocation to the US, really. So even if it comes down moderately, that'd be a huge amount that comes out of US dollar assets. You know, I spoke to one analyst who said, you know, just across European pension funds, if they went back to their pre-COVID allocation, it could take, you know, $250, $300 billion out of assets that they're selling out of. Yeah. They could, though, you could just have people
their exposure or their allocation by just letting bits of their government debt holdings run off over time. It might not all be sales, but I think how big this wedge is that we're at the thin end of is a really important question. And pension funds, as you say, are very slow moving. I started out my career as a pension fund journalist and maybe it's a quarterly meeting where they discuss this.
And I suppose the most positive view you could take for the US here is that if you give it a year and some of these threats to US institutions have not materialized, that people won't make changes to long run strategic asset allocations that are big enough to really shift the market. And perhaps the trade war by that point is much more muted. We're already seeing signs of capitulation.
And that you won't then, that slow moving money won't significantly shift. The bare argument is it will shift for those very kind of firmly held views you mentioned earlier that people have about US and its relationship to Europe. And that actually it would just be a slow burn over time. For what it's worth, my money is on a slow burn, right? Because...
So say currently the US makes up about 60% of global indices or 70% of developed market indices. And that's partly because US tech has done so fantastically well and you've ended up with such enormous companies and these indices are weighted by market capitalization. But that's a much bigger weighting than you can argue should be appropriate because of the size of the US economy. And it's even
It's even a really big allocation compared to how much of a slice of global earnings comes from the US. So even if you account for kind of profitability, still somehow we've ended up in a world where the US is home to just such enormous companies that there's like too much money globally put to work there.
But what I'm hearing from investors is, look, nobody seriously thinks that big pension funds and whatever are going to say, right, I've currently got 60% of my stock market exposure in the US. I'm going to take that down to 25. That's not going to happen probably ever and definitely not going to happen overnight. But what I think probably is going to happen relatively quickly is, you know,
Every month, my pension takes some money out of my paycheck and puts it to work in markets. Now...
Do the good people who are looking after my pension mechanically keep sending 60% of that to the US? Or do they say, maybe we'll make it more like 55 or more like 50 and we'll just scatter a bit more of that money somewhere else around the world? So that's why I think this is going to be a really slow puncture for the US. It's going to take a really long time for this to crystallise. Unless, as you say, there's some sort of miracle and investors...
fears are assuaged somehow and they say, OK, this has all just been a bit of a Trump blip. But I mean, what sense do you get from people around how long this is likely to take?
It's going to take a long time. There are reasons why the dollar assets are supreme, some of which we've mentioned. Others, you know, dollar share of global trade, treasuries as the world's de facto reserve asset. And as we know from reporting through the kind of COVID period, when there's a real crisis, there's a rush for dollars. So I think, yeah, dollar dominance means that kind of treasuries are always going to have that role. Plus,
the US$29 trillion US Treasuries market is way bigger than any rival. So there's this question of how far this could really go, given that Eurozone debt markets are just a fraction of that US$29 trillion. But we are going to get more bunds. Germany is spending more. So the positive argument to be made here for Europe is that
Europe is turning on the spending taps. Germany is going to be borrowing more. So you have more of these AAA reserve assets in the Eurozone that these real money investors that you talk about like to be in. And it's more of a diversification from dollar assets to...
into things like German government bonds, which has always been a haven asset for investors, but could hold a bit more of a share of your pension fund holdings, could hold a bit more of a share of your reserve manager at central banks holdings. And this is something that plays out slowly over time. But yeah, there are limits, you know, much shallower markets in Europe. So all that money can't
And all that money won't move. I think something else that we might see, which might be playing into the dollar weakness that we've already seen, is people moving to hedge where they haven't hedged before, that currency risk that we were talking about earlier. So European investors say, OK, I still want to invest in the US.
But I want to take a little bit of a hedge out just in case the dollar keeps falling like it's doing now. Yeah, and I'm hearing a lot of that from investors and from bank strategists saying that they're hearing that from their clients. There's a lot of appetite in hedging and some people put...
numbers on how much that could be so Bank of America have said that if you shift back to kind of pre-COVID levels for how much of that currency risk that global investors hedged you could have a five trillion dollars of extra currency hedging of dollar assets by global investors or two and a half trillion of kind of hedging coming from Europe and
And that's mostly on equities where there's been this large unhedged position. So it could be that what we don't see is a huge shift away from dollar assets, but we see a kind of de-risking of those dollar assets through massive hedging, which itself exerts more downward pressure on the dollar, such as we've seen kind of play out in some of the kind of exchange rates and concessions. Yeah.
It'll be interesting to see to what extent the kind of real money world decides to hedge that dollar risk or really try and reduce its US allocation. Look, it would be great for my pension if it did turn out that this was all a blip, but it would be annoying in a way if those optimistic Americans were right all over again. They need more of our money.
cynicism Ian this is what we need more of in the world it's our principal export yes it is we don't export stuff anymore is it going to be tariffed yeah tariff my cynicism yeah exactly we're going to be back in one sec with long shot we take very long duration liabilities
very stable, very predictable. We match them with very long dated, ideally matched asset allocation, taking advantage of the illiquidity premium, using the illiquidity that's inherent in those liabilities to match them and provide a levered spread between the cost of liabilities and the yield on the assets. Speaking of alternatives, the new podcast from PGM, tune in to hear more.
Okie doke, it's time for Long Short, that part of the show where we go long a thing we love or short a thing we hate. Ian, I gave you fair warning that this was coming up, so what you got? I'm going to go long butterflies. Oh, isn't that nice? Hey, it's no mow May, which in the UK means we don't mow our lawns, we let them grow. Oh, I wasn't going to know it anyway. You don't mow any time, no mow 2025 for you. And yeah, we sowed some wildflower seeds yesterday with my kids.
This is beautiful. I'm so glad you've come on the podcast to talk about beautiful butterflies. Hedging and butterflies. Well, by contrast, I am long misery. Brilliant. So, as saw from Chris Giles' email today, the University of Michigan Consumer Sentiment Index has tumbled. It's only ever been lower briefly in 2022 and 1980.
In Britain, the Economic Optimism Index from Ipsos Mori has fallen to its lowest level since the survey began in 1978.
Eurozone consumer confidence has dropped. Everyone is miserable apart from Ian Smith, who's happy thinking about butterflies. It's a cure for your Trump derangement syndrome. Put a butterfly in your garden. What a beautiful note to end on. Listeners, we'll be back in your feed on Thursday with or without butterflies. So listen up then.
Unhedged is produced by Jake Harper and edited by Brian Erstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.