Will the real money pivot to Europe?

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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 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.

And 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.

I did.

For some stupid reason, you decided to move over to markets from insurance.

Are markets driving you around 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 have come back.

So, I think I am the problem,

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 castes.

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 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, 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?

Are massively investor confidence from Europe in the US has just been shaken in recent months.

And you can view it across US policy making, tariffing penguins,

the Federal Reserve independence, that coming under question, but also how investors have been burnt by this massive bet that they've made on US equities.

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 US 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 SP 500 is down around 4% in dollar terms this year.

But if you look in the 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, right?

A lot of those bets on big tech stocks like Nvidia have not been doing so well past 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, US markets have had a horrible run.

Just looking at my little screen here, the SP 500, the big index of US stocks, is down like 4% so far this year.

Whereas even the FTSE 100 in the UK 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 institution really big investors yeah yeah so they're now reappraising the dollar as a 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 in recent months has been some of the downsides of the US trade policy playing out for the US economically, but also this galvanizing 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 like Rob and I argue about on this podcast a lot, is that

there's a rally round 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 sort of

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,

criticising 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.

That looks like exchange-traded funds.

Yeah, if you look at these exchange-traded funds, but look at ones that are domiciled in Europe,

invest in US stocks and U.S.

bonds, those funds lost about 2.5 billion Euros in April, according to Mordingstar 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 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 big debate in the market is how far has that gone and how far can it go?

Yeah, no, exactly.

So if 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

other kind of fast-moving money managers.

On the other side of the coin, you've got real money, which is pensions and 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 we're going to change our asset allocations.

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

I, you know, I 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 comes from a very high point in terms of the allocation to the US, really.

So even if it comes down moderately, that would 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 $250, $300 billion out of assets that they're selling out of.

They could, though.

You could just have people...

reducing 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 yeah, 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's 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 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 sixty percent of that to the US, or do they say, maybe we'll make it more like fifty five or more like fifty 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 crystallize, unless, as you say, there's some sort of miracle and investors' fears are assuaged somehow and they say okay 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 um others you know dollar share of global trade treasuries as the world's de facto reserve asset and as we know from you know reporting through the kind of covert period when there's a real crisis there's a rush for dollars yeah um So I think

dollar dominance means that kind of treasuries are always going to have that role.

Plus the 29 trillion dollar 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 29 trillion.

But we are going to get more boons.

Germany is spending more.

So the positive argument to be made here for Europe is that Europe is turning on the spending taps.

Germany's 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 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 bank's holdings.

And that this is something that plays out slowly over time.

But yeah, there are limits, you know, much shallower markets in Europe.

yeah so all that money can't move 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 so European investors say okay 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 that.

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 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 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 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 as we've seen kind of play out in some of the kind of exchange rates in succession.

So it'll be interesting to see to what extent the kind of real money world decides to hedge that dollar risk or 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 cynicism.

Ian, this is what we need more of in the world.

It's our principal export.

Yes, it is.

We don't export more stuff anymore.

Is it going to be tariffed?

Yeah,

tariff, my cynicism.

Yeah, exactly.

We're going to be back in one sec with a long short.

Bonds are back.

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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.

Wow, isn't that nice?

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 mo.

No Mo 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 butterfly.

Hedging and butterflies.

Well, by contrast, I am long misery.

Brilliant.

So, I saw from Chris Giles's 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.

The butterfly in your garden.

What a beautiful note to end on.

Listeners, we will 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 Erstat.

Our executive producer is Jacob Goldstein.

We had additional help from Topa 40.

Cheryl Brumley is the FT's global head of audio.

Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Seidler.

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 Thanks for listening.