Asset manager Paul Jackson warns of a correction on the US stock market

You think US stocks are extremely expensive and describe AI as a bubble that will burst at some point. How are the two things related?

The American stock indices are so expensive at the moment because a number of stocks that are seen as being linked to AI have climbed to extreme heights.

How dangerous is this?

History tells us that expectations are usually disappointed when stock markets are as highly valued as they are today in the US. Over a ten-year period, this leads to modest or even negative returns at best. Taking this risk is unnecessary, as there are much better alternatives available at the moment, particularly in Europe.

In recent years, investors have repeatedly experienced that the American economy has grown dynamically while Europe has disappointed. Won’t that happen again?

This year it is different: Europe is making a positive surprise, while the US economy is developing slowly, even poorly. Real disposable personal income has fallen in two of the last three months. The US economy is losing momentum.

Could Europe suddenly emerge as a winner for once?

Exactly – and when you previously described the American economy as dynamic, that is only partly true. The economy in the USA is growing faster than in the EU, but on a per capita basis it is the other way round: Europe is ahead. The impressive American growth is an illusion and is mainly related to population growth.

Shouldn’t it be irrelevant to investors whether growth is driven by demographic trends or higher productivity?

Of course, you can argue like that, but then there are markets with a much better population development – such as India, Indonesia or markets in Africa. And China, with which many investors have concluded deals, is still growing much faster than the USA, even though its population is stagnating. And even though China stimulates its economy less than the USA.

What do you conclude from this?

We should question the quality of growth in the US. It looks so good because successive US governments have pumped a lot of borrowed money into the economy. During the pandemic, for example, households received more money than they could spend, and that created a consumption boom that has now come to an end.

If Donald Trump comes back, the US would probably accumulate much higher government deficits and another boom could follow, right?

Whoever becomes the next US president has a problem. The national debt burden has risen to 120 percent of GDP, and because the yields on US government bonds are much higher today, the cost of servicing the debt is rising considerably: Since the bonds have an average maturity of 5 years, this will only have a delayed impact. But even so, the US is already spending more on debt servicing than on defense, and this could represent a kind of tipping point: Now politicians are starting to get uneasy about the issue of debt.

Back to the scenario of a second Donald Trump presidency. How do you view this?

The biggest concern is his attitude towards the Fed. Trump thinks he should be able to influence its decisions. I’ve heard he’s even considering nominating one of his sons as Fed president. Something like that would have the potential to destabilize the US financial system.

In your model allocation, you have drastically reduced the weighting of equities to 35 percent of the total portfolio. With a neutral positioning, this would actually be 45 percent. Why so pessimistic?

This is solely due to the fact that we have such a negative view of US equities. We see positive developments in European markets, China and the emerging markets. The problem, however, is that because US equities make up such a high proportion of the indices – around 70 percent – we end up with a negative assessment for the entire equity segment. I even cheated a little, otherwise the equity share in our model would have been even lower.

Should you stop holding US stocks altogether?

Other markets are much more attractive: If you still want to buy American stocks, you could, for example, invest in index products that do not apply capital weighting but treat each stock equally. This way you can avoid a large concentration of extremely expensive stocks.

You have also reduced the weighting of high-yield bonds to zero and instead recommend overweighting commodities and REITs – i.e. real estate investments. Together with your strongly negative assessment of the USA, it seems as if you are currently leaning towards extremes.

I have a consistent focus on valuations. At the beginning of the year, we were still overweighting high-yield bonds. Their prices have developed very well since then, and today investors are hardly compensated for the additional risk. And as far as the USA is concerned, I have a problem with the blind faith of many investors in capital-weighted indices.

What do you mean?

When I started my career in the 1980s, Japanese stocks accounted for 70 percent of the world stock index excluding North America. Everyone thought that was normal, that the Japanese stock market would continue to rise. When US stocks fell by 22 percent in one day on Black Monday in 1987, Tokyo only fell by 2 percent the next morning. We all know what happened to Japanese stocks after that.

Could it be that hardly anyone questions the high proportion of US stocks in the relevant indices because it does not pay off for professional investors to deviate from the mainstream? They could even lose their jobs if they position themselves differently than the masses.

That certainly plays a role, in addition to the human tendency to simply extrapolate the recent past into the future. But it is wrong to simply take such imbalances for granted. And then celebrate it as outperformance when the overall market falls by 12 percent and your own portfolio only by 10 percent. It is absurd to talk about outperformance when customers lose a lot of money. The obsession with comparison indices can therefore be dangerous; I prefer to think for myself and focus on the fair value of investments.