American ‘Economic’ Exceptionalism

SUMMARY

• The US economy continues to outperform its peers.
• We believe this relative strength will continue.
• Economic strength is positive for stocks but creates near-term policy uncertainty.

The term ‘American exceptionalism’ refers to the belief that the United States is a unique and potentially superior nation for historical, ideological, or religious reasons¹. Often first attributed to 19th century French political scientist Alexis de Tocqueville, the phrase can be controversial, depending on what side of the ideological or religious divide you find yourself on.

Why the US Economy is ‘Exceptional’

That said, simply looking at this claim in terms of what affects the markets we invest in, we believe there is strong evidence of what we call ‘American economic exceptionalism’. This refers to our view that the US economy is structurally more robust and resilient than its’ developed world peers. This point is getting harder to refute quantitatively, with the US’ remarkable relative rebound coming out of COVID-19.

As can be seen in Chart 1 below, the US was not only growing faster than Europe or Japan heading into the 2020 pandemic, but it also dropped less during the pandemic AND rebounded more powerfully coming out of it. Most remarkable, the US economy – the world’s largest - is 11% larger today than it was in 2019. Meanwhile, Germany and Japan’s economies are essentially the same size as pre-pandemic, and France and the UK are only marginally bigger².

What Makes the Us Economy ‘Exceptional’: Productivity is Key

Chart 2 below, measuring real GDP per hour worked, suggests that US productivity has been on the rise for decades, and seems to have accelerated on a relative basis since the pandemic. What facets make the US economy so productive? The reasons are myriad and deserve deeper exposition than we have space for in this publication. However, at the risk of oversimplifying, we think it boils down to three major differentiators for the US:

• A culture of innovation and entrepreneurship: Our higher education system turns out many of the world’s foremost innovators (and innovations) in technology, healthcare, and engineering. The power of artificial intelligence (‘AI’ – see our Weekly View from 9/5/23 for our thoughts on AI) will likely only extend this lead. This track record of entrepreneurship is supplemented by low barriers to starting a company, relatively pro-business regulatory environment, strong intellectual property (IP) protection, and deep, established capital markets. These characteristics result in the US remaining a bastion of entrepreneurship compared to Europe or Japan, in our view.
• Greater labor flexibility: We believe the US labor market is more flexible than those of Europe or Japan. Companies in the US are less encumbered by regulation and more able to flex their workforce up and down in real time to meet changing industry conditions, protecting profits and increasing productivity in the process. While this can make employment more stressful for workers, it allows for greater employee mobility and, in our opinion, leads to greater employment opportunities en masse. We think this point is backed up by the US leading its developed peers with the lowest unemployment rate at 3.7% as of January 2024.
• More advantaged demographics: Unlike much of Europe or north Asia, the US boasts a meaningfully younger demographic and a population that’s still growing. This is in large part thanks to the ‘Millennial’ and ‘Gen Z’ demographic cohorts, which represent two of the largest ‘baby booms’ in US history. Consider the median US citizen age of 38.5 years old, versus Germany at 46.7, Italy at 48.1 and Japan at 49.5 (data: cia.gov, 2023 estimates). While China’s median age skews a bit younger than Japan or Europe at 39.5, their population has now started to shrink for the first time since the 1960s (see Weekly View on China from 8/29/23), suggesting their demographic dividend is now well behind them.

What it Means for Stocks…Strategic Benefits of Economic Exceptionalism

For both US stocks and for the US dollar, being connected to a more productive, growing economy has myriad benefits… not least of which is the strong long-term correlation between US GDP growth and corporate earnings growth (Chart 3, below).

As equity investors, we care deeply about corporate profits…and thus we will take a structurally stronger economy over a weaker one any day – even if it means a slower interest rate cut cycle! While interest rates are a powerful driver of near-to-intermediate term stock sentiment and valuations, in our view corporate earnings are the more durable longer-term driver of a stock market’s returns (see our 2024 Outlook for more on this topic). Our Outlook calls for corporate earnings to be stronger than consensus believes in 2024.

Tactical Perspective: Some Near-Term Challenges with a Hot Economy

However, from a tactical perspective, this economic strength may paradoxically also create near-term market volatility in 2024, as the economy’s buoyancy has stoked uncertainty about future Fed policy. While the market entered the year expecting five to six interest rate cuts from the Fed, RiverFront believed that the economy’s strength and the uncertain path of inflation from here would lead to fewer cuts. While the market has now come closer to our way of thinking – now Fed funds futures markets are now only pricing in approximately 3 cuts this year – we still believe this may be overly optimistic.

In the shorter run, we will also have to accept the additional market volatility and occasional scares that are likely to accompany speculation around the Fed and future inflation readings. The first half of presidential election years tend to be volatile for stocks, before generally resolving to the upside…and we expect the same in 2024. Thus, we expect alternative yield strategies which benefit from increased volatility to be a useful investment strategy for the current backdrop.

Conclusion

We believe ‘US Economic Exceptionalism’ is one of the main reasons that the US economy and stock markets have structurally outperformed international peers. We think this is likely to continue for the foreseeable future despite cheaper valuations overseas, a topic we covered in detail a couple of weeks ago in our Strategic View on developed international.

^{1 Definition courtesy of Encyclopedia Brittanica: https://www.britannica.com/topic/American-exceptionalism}

^{2 Note: We chose not to display China - the world’s 2nd largest economy - on this chart. While official Chinese National Bureau of Statistics (NBS) data suggests the mainland economy is about 14% larger than in 2019 on the same metric, there is widespread skepticism – which we share – about the credibility of that data. It is widely believed that the national GDP is heavily ‘massaged’ by the Chinese Communist Party for political aims – see our Weekly View from 8/29/23 for more on this topic.}

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.