Transcript: End of US Exceptionalism and Europe’s reawakening - an epic turnaround or a dead-cat bounce?

Air Date: July 7, 2025 | 12:00 PM, EST

Caroline: Good afternoon, everyone, and thanks for joining us. I'd like to welcome you to this week's Monday Minute Chat, hosted by the Canadian Leadership Congress. The topic today is the end of U. S. exceptionalism and what that means for both the global economy and asset allocation. And here to talk about this is Luca Paolini, who is Chief Strategist, Multi-Asset and Quantitative at FICTE. And moderating the discussion with Luca, we have James Davis, who is Chief Investment Thanks very much, Caroline.

James: It's really great to be here. I started to pull together a script for how I thought this discussion should go. I did have a brief chat with Luca last week, and it just seems that the topic is so rich and there's so much changing and it's so dynamic, that I thought maybe we would abandon the script and just go kind of in the direction that the conversation takes us. So good to speak with you again, Luca. You've got some great insights to share. I'm looking forward to our discussion. I just want to start off with this idea of a transition. Something is happening in the United States. We've seen a huge swing in the direction of policy and also in the direction of sentiment since the new U. S. administration came into place in January. And some of the changes in direction perhaps have not been surprising. They've been well telegraphed, but I think perhaps what is surprising is the speed and the magnitude of some of these policy shifts, especially as they relate to trade and also to geopolitics. Many asset classes have been impacted, and most markets. In fact, the U. S. dollar is the one that I want to focus on at first because that's declined almost 11% since the beginning of the year. And that may be a bellwether for what we might expect in the future for the United States and hence the discussion around U.S. exceptionalism. So what I'd love to get a sense of, Luca, is how you're thinking about that. Do you think that we're going to see a continuation in the weakness of the US dollar?

Luca: Yes, and hi James, and hi everyone. It's great to be here. And yes, look, I think that the first thing that I want to highlight is that some of the trends that we are seeing now that actually started even before the Trump administration. So the Trump administration is more like an accelerator to existing trends. The dollar is the one that in a way is more visible. And I think also the one that will stand in power in a sense that we do believe. That the dollar has peaked, both cyclically but also structurally. And as you said, it is right. For me, the currency is always a barometer of how a country is doing. There's this kind of probably old idea that a weak currency is good because you can export more. I think it's the other way around. A strong currency is an indication that demand is strong, the economy is strong. You may export less, but it's always better to have a strong currency than a weak currency. So in a way, the Trump administration – if it makes sense – we have so much money; especially so much pension assets in a country that seems to be happy to be left alone and isn't the America that we used to know. And so I think, yeah, there is a big change in sentiment. And as you correctly say, it was incredibly fast. You know, just a few months ago, most investors thought the U. S. was in an uptrend. There would be tax cuts and all these kind of things. And after a few months, we realized that Europe has outperformed the U. S. by the most in decades, which was totally unexpected, which is, again, great.

James: So when I think about currency, I think about what drives it being trade flows and, of course, capital flows. And you mentioned Europe, and Europe has certainly been on fire this year. So when you think about the underperformance of U.S. Equities relative to the rest of the world, is there something bigger happening from a capital flows perspective? So we know that tariffs have certainly had an impact on the potential for trade flows looking forward. The US and think about it in the context of something that is more of a regime shift as opposed to, say, a mean reversion. So when we think about U. S. exceptionalism, and it's been exceptional for a number of years now, maybe this is just a mean reversion. Maybe there's something that's going to happen anyway. Or maybe there's something bigger here and there's a real regime shift underway. Love to get your thoughts on that.

Luca: I think it's a little bit of everything. There is also a cyclical element to it, right? Because you've seen US growth now being much weaker than it was just six months ago. There is also a cyclical element. see growing strongly, but maybe markets have been in a way for a long time exaggerated the strength of the US economy and everything else. So I think for sure we're expecting capitals to flow out a little bit from the US. This is a huge implication because when you have a lot of capital inflows, as the US. said in the last few years, it means that bond yields are lower, it means that your currency is stronger, and it means that sustainable. And you've already seen, again, the capital outflow. I think it will continue, maybe not at the same pace. But again, there are also risk management considerations, excessive concentration in the US in terms of financial assets is something that is not, I think, sustainable.

James: Yeah, but what about culture? Think about business culture in the US. There's a spirit of entrepreneurialism. It's almost ingrained in the way things are done in the US. There's a preponderance.

Luca: Well, we're not saying the US, again, the US is the best place to do business. And you're totally right in terms of culture. We don't have the same, we're not everywhere in Europe, we have the same culture. For example, in Europe, we say roughly 15% of our monthly income in the US is fine. It's not going to change. So when we say Europe is going to spend, there is a cultural element to it. We tend to save and the US tend to spend. That's not going to change. To be, you know, at the end of the queue is still, you know, the strongest economy, the most dynamic. This is not going to change. The question, though, is should they pay a 30 or 40 percent premium for a U. company relative to a non-U. S. company just because it's based in the U. S., I think 30%, 40% is right. There will still be a premium for U. S. companies, probably, though, of 10%, 20% instead of 30%, 40%. So that's what we are talking about. It's more like the price of U. S. exceptionalism will not disappear, but definitely will be de-rated in a way compared to what has been to us, a little bit of a bubble in the U. S. in the past few years.

James: But the future is technology, and the U. S. is the global leader in technology. Think about AI, notwithstanding what we heard from China earlier in the year with respect to DeepSeek. But if we think we're only at the beginning of AI, and that's just one example of technological innovation, and if the U. S. is the leader, shouldn't we still want to place our bets there?

Luca: But, you know, the leader of today may not be the leader of tomorrow, right? I think if you look at China, for example, China in some areas is well ahead of the US. You know, we can talk about drones, even robotics in some areas. Clean energy, we tend to forget. It seems like, you know, now nobody's talking about the green transition, clean energy and all this kind of thing. China is miles ahead of the U. S., even Europe. Some even said that China is an electro-state where the electrification is far, far ahead, even of European levels. And these things matter. So again, there is no question, the US in five, 10 years time will still lead in technology. But the question is, will the lead be so dominant as it has been in the last 10? We think that new champions, new winners will emerge and may not be in the US. And the fact that China has done incredible-you know, 50% of European energy is basically come from renewables. And this is also part of technology. We tend to think technology is only chips and this kind of thing. There's a lot of things that goes into, you know, in different industrial sectors. So again, no question, the U.S. Is still leading, but not by the margin that we thought the U. S. had just a few months ago, really.

James: So the electrification, that's a good point. And China is certainly taking a lead there, at least from a clean energy perspective. But just linking it back to AI, we know AI requires massive amounts of energy. And so there has to be a lot of investing in the US if they're going to maintain a leadership role in AI, in electrification and in energy production. How should we play that? So if you think about it in the context of renewables, we know that's been important. It's been a great theme. But I'm wondering now at this stage of the game, should we be thinking about nuclear?

Luca: Absolutely. You see that also in Europe, there's a change of heart on that. I think it's the future. I'm afraid that it's not only for the demand of energy coming from AI, but also from a purely geopolitical element, right? You want to be independent. From that point of view. And I have to say that, again, I'm not here to be chief leader of Europe, but Europe will gain massively from renewables, just because in Europe, we import roughly 3% of GDP, in a way, worth of energy. But the US is an energy exporter, right? So renewables will actually boost European growth, and in relative terms, that's negative for the US. But yes, there is no question there will be a revival of nuclear energy, again, But I think when you look at the cost of the logic, the business logic behind it, I think there are, I think, huge advantages to that. Again, I don't think the U. S. will benefit more than anyone else, but definitely that's a trend that we see pretty much everywhere. So I think it's going to be, I think, a big thing in the next decade.

James: So energy independence is super important from a geopolitical risk management perspective. And so at the end of the day, Europe may have an advantage in that particular area. How best to play that in the context of nuclear? So would we want to invest in uranium, for example?

Luca: This is obviously one way to do it. There are some companies that directly exposed to the team. You have to go really country by country. Again, this is a local business, right? If you want to protect or to make sure to be energy-independent, but also to have control of the energy sources, everything will be done pretty much locally. And so that's really like more the job of stock picker more than a strategist. But there is no question that, again, So, you know, it's very important. And again, it's a global race. And it's a race where the U. S. doesn't have an advantage because shale oil, for example, is expected to peak in 2027 in terms of production. If everybody goes, let's say, nuclear or will invest in renewables, well, again, this kind of geopolitical advantage was massive in the U. S. in the past eight years. We'll not disappear. Don't get me wrong. We'll not disappear, but we'll be less relevant.

James: That's leading to fiscal spending and bringing it again back to Europe. We know that there's a commitment to much more defense spending and getting more in line with what was pledged as part of being part of NATO. Canada is in the same situation. And so this should be a tailwind for economic growth. But thinking about geopolitical risk and how we should best manage this. So beyond thinking about whether I should be in the US or I should be in Europe, how else should I play this geopolitical risk theme? And in particular, how should I manage this risk?

Luca: You know, it's a great question. And my answer is always the same. We tend to, we love to say geopolitical risks are rising, they're high. They've always been high. I mean, apart maybe for a few years in the 90s, but even in the 90s, we had some real shocks. You know, this would always be geopolitically risky. Is it now much, much riskier than it was 10 or 20 years ago? Honestly, I'm not so sure that that's the case. But I don't think that we are living in a phase of our life that is geopolitically much riskier than it was, for example. Remember, in the 60s, we were very close to a nuclear war. So I think it's very important to highlight that in a way we have this kind of period in the late 80s when anti-war was relatively safe, but after that was actually a series of very kind of unpredictable and bad events. So what is the best way to manage that? First of all, don't guess. Because one way that I think is the wrong way to do it is to say, well, we are living in a very risky geopolitical world. Play safe, put your money in cash, and let's wait for the geopolitical risk to dissipate. It will not dissipate. They will stay with us. So we have to manage the risk actively. Not, I think, be aware of what history has told us, that this is relatively normal, it's nothing new. What is clear though to me is that we are seeing a new order, a newer order emerging. Where before was just about the US satellites that they were effectively running the show. Now you have China, you have Russia, we see. So it's a much more fragmented, complicated world in a way. I don't want to say necessarily riskier, but more complex than in the past. So what can you do? Well, for us, first of all, it means that you should structurally have a higher kind of position in gold, brain, for example, even if COVID is not geopolitics, but there was also a political angle to it. There is typically a phase of panic. We think we are in a completely new environment, right? And then after a few months or a few years, you realize that it was a shock. It was painful, but we're pretty much back to the previous trend. So for me, it's more like an opportunity. Try to exploit this kind of irrational reaction to geopolitical events by focusing on what are the clear long-term trends. Because, you know, geopolitical risks are unpredictable. What you don't want to do is to be overly exposed to any country region in the world. Could be US, could be China, could be Europe; it's the same. So you have to be diversified. More tactical and having, I think, a good weight in gold that you keep there just in case things are going really wrongly. So, that's what we do.

James: What's a good weight in gold, Luca?

Luca: Well, we have five to 10, depending on obviously of your time horizon, your risk profile. You know, we run an optimization process by looking at correlation, expected returns, and we tend to get a number close to 7, 8% for a global multi-asset portfolio, which I think is realistic because also we have to be aware that with gold, you get zero income. So, yes, we love gold, but if we have 20, 25% in gold, so lots of opportunities.

James: I agree with you with respect to gold, but I think there are lots of opportunities as well. Just thinking more broadly about how we manage risk. I'd like to explore a few of those. Defense stocks. What about investing in defense and defense technology in particular?

Luca: Well, you know, you look at the sum of defence stocks, especially Europe, because let's be very honest, the change here is in Europe, not in the US. The US has been spending on defence roughly 3% of GDP for the last decades, even more. Europe is moving from 2% to potentially 5%. Even if this 5% that is talked about, which is the target of military spending on GDP, is a bit unfair because it's 3 . 5% plus 1 . 5% in cyber security and infrastructure. But let's say if Europe goes from 2%, push for more spending on defense when you have a war just a few hundred kilometers away. But if the reason at some point there will be a ceasefire in Russia and Ukraine, well, then I suspect that some investors, especially some voters, will start thinking, do we really need to spend 5% on GDP? To on the fence where our schools are not good, where hospitals are crumbling. So I don't think it's definitely a sacred uptrend. I suspect the valuation now is maybe a little bit too rich. So there is probably more money to be made investing in industrial companies. There are still, there is an angle, defense angle, but they're not just defense company only because I think they're very vulnerable to the political climate. And we have plenty of them in Europe, also in the US. And also let's not forget that a lot of this kind of defense spending will be done on tech. Sometimes we think that it's just ammunition and tanks. It's cybersecurity. There is a lot of tech involved, industrial. I wouldn't be surprised in a few years' time if there is an end to the war in Russia and Ukraine, you know, it would be politically very difficult to defend such kind of spending when other parts of the welfare state, you know, we love the welfare state in Europe, are not doing that well.

James: So, the traditional diversifiers, the safe havens, always included the U. S. dollar and U. S. treasuries. And we talked about the U. S. dollar, and it doesn't seem to be behaving. We can see that in the most recent environment, especially with what's been happening between Israel and Iran. You're not seeing that same movement back into the U. S. that you might have seen a few years ago, portfolio. But we're not seeing that. I'd love to get your thoughts on the direction of yields in the United States and keeping in mind the significant debt level that the U.S. has. And we've got this big, beautiful bill now that's going through Congress in the United States, which at the end of the day is going to exacerbate deficits.

Luca: I think when we talk about the safe haven asset, I think it's clear that U. S. Treasuries are not playing this role anymore. And again, I hope that if we have U. S. investors listening to this call, they won't be angry with me. But the reality is that U. S. is behaving like an emerging market. And I like the U. K. as well. When you have bond yields going higher and at the same time, you have a decline in the currency, which again, an indicator that there is a vote of no confidence. You buy, you cannot buy really Chinese bonds because the renminbi is not fully convertible. You can think about bonds, but bonds are still, yeah, they're liquid, but it's relatively small. So Europe has a chance if there is a joint issuance of bonds from the European Commission, I think Europe may actually play this role as safe haven. Currently, we cannot because we are too fragmented. So what is the impact on U. S. bond yields? It's important to highlight that, you know, and they're going to use that we have money. But if you have, you know, if you're relatively, let's say, if you want to save for the future, you're getting older, though, you need income. If you invest in equity, especially in the US, you have fantastic companies, but almost no income. So there is, I think, an underlying demand from domestic investors for fixed income products that gives you four to five percent. So that's why treasuries haven't really sold off completely, because there is a strong underlying demand coming from domestic investors. Mainly because growth will be weaker. Inflation will be slowly returned to 2%. The real risk here, the real risk, I think, is the Fed effectively giving up its independence or being forced to give up its independence, you know, in a different way. I mean, Trump may actually fire Jay Powell or other things. Maybe Congress would introduce legislation that forces, you know, a certain course of action for the Federal Reserve. And effectively forgetting that there is a market out there that, you know, may not like what you're doing. But, you know, we feel that we are more on the optimistic side. The deficit will continue to be very high, not getting worse. And probably investors will move to the next big thing, which, again, we don't know what will be.

James: So we haven't talked a lot about inflation. And I want to before we get into that a little bit more, I just want to talk about that in the context of yields. And you mentioned, you know, changes of regulation. So the U . S. changes regulation banks. are required to own more bonds that provides more demand and allows for more supply. In my mind, that's financial repression. And so we could see that expand. And we could see it where pension funds, for example, insurance companies, pension funds. Other. institutional investors are required by regulation to own more U . S. Treasury bonds. And you could do that in an environment where inflation is running a little bit hotter, making it a little bit easier to finance the debt. From my perspective, that goes hand in hand with how governments have traditionally got themselves out of. out of debt, which is higher nominal GDP, primarily driven by modestly higher rates of inflation, which of course is not great for the currency. But then if you're an administration who would kind of like to have a weaker dollar, maybe that all fits together. So you get this nice, neat little package. And Besson just said himself, one of his primary goals, the thing that he watches more than the stock market is what's actually happening to bond yields. So do you think this potential avenue?

Luca: It's possible, but there is a very, very narrow path that US administration has in front of it because You can obviously make the point that with interest costs already being higher than defense spending in the US, well above 3%, you can already have much higher interest rates because this will generate effectively a big decline in demand. So you can already have much higher interest rates. But if you have it much lower, you have inflation. And if you have inflation, the first thing that happens is, by the way, I'm Italian. I grew up in Italy, where we were saying 'there is', though, and as you mentioned correctly, so a potential of what? Let's say the Fed keeping rates as low as possible in a way to still keep an inflation around three. Three is probably the level where you can still pretend that it's temporary. You know, it's something that you can and probably it's also the electorate can accept. Anything above three, you're going to lose the election and you have a lot of questions that you have to answer. So I can see a situation inflation around three, not two. And the US administration running a deficit of six or seven, pretty much where it is now. What is the problem with this, James? That, you know, when we look at this scenario where the real growth would be actually pretty weak. Because all the growth will come from inflation. If you have, you know, a normalization sort of monitoring fiscal policy, in our view, in our calculation, you take out roughly 40% of the growth that US had in the past five years. So, and that's where it's a very narrow path. And the regulation to me is not an issue because the regulation may help some sectors. And in fact, the regulation and cheap money ends up in, you know, bubbles, which again, you may want to have if you are participating, we haven't talked about digital assets-are you a proponent of digital assets, in particular Bitcoin? Look, I've never been a big fan, and I was clearly wrong, right? And the reason why, because I never really, and I have a lot of friends at Bitcoin, and they told me, look, you should invest. And I said, okay, give me a reason. Maybe I studied too much economics. I don't see an obvious economic logic of a digital account the way that Bitcoin is done. I think the blockchain technology is absolutely amazing. I think, though, that again, when you look at the past few years, we have to admit, and to be honest with you when everything is falling apart-if you think and it's not my view. Well, you know, Bitcoin can provide a form of diversification and protection from, you know, a complete failure, for example, of democratic political institutions, right? And, you know, from my point of view, one of the major risks was a change in regulation that made Bitcoin uninvestable. Now we are exactly the opposite. Our administration is pushing for it. And from the latest polls, it suggests that roughly 20-25% of Americans-to tell these people that are obviously voting in elections to, well, you know, you made a mistake. You know, we don't want you to own Bitcoin. So I think we've reached the point where Bitcoin is inevitably an asset class that will be taken seriously. I think investing in passive crypto makes some kind of sense, but I'm incredibly low. I think I wouldn't go above 2%, and I personally don't own any Bitcoin, but I can't blame anyone if they want to put 1% or 2% in a passive crypto investment and see what happens. It's a lottery ticket. If you win, you win big. If you lose, you don't lose much. I still believe, though, that, again, I still don't see the logic.

James: And the change in regulation around stablecoin is another theme that's playing out. And so it's related, obviously, to digital assets, but it's also related to the potential demand for U. S. treasuries, because you need somehow to back these stablecoins. So again, I might come back to that theme of a regulatory environment, which is in many ways encouraging folks to accumulate treasury bonds, helping to keep bond yields lower.

Luca: Yeah, you're totally right. If you think about stable coins, the way they work, you give, you know, the stable coins company one dollar and effectively what they give you is a coin which is backed by treasury. So effectively increase the demand for treasury. And I think if you look at all the stable coins operator, now they own more treasury bills than China. So I think it's important to highlight that wherever you look at it, this is a significant risk for the system. Because, you know, we know with stablecoins, you've seen this for money markets in the global financial crisis, it's safe until it isn't. And because the size is becoming bigger, I can see why this could be a source of risk. And I think there's something you have to keep an eye on. I don't think that the U. administration is looking at Bitcoin as a source of, let's say, buyers for treasuries. I think what they think is that having a leadership in stablecoin support the dollar in the U. S. as a place to do business. But I agree that this is, to me, it looks like pretty much like money market funds. And so I don't want to say it will end up in the same way.

James: Are you big on emerging markets?

Luca: We do, because, you know, when you look at emerging markets, you know, I know the stories that, you know, they're very different from each other. The past few years, you know, nothing working. But by the way, it's not correct because emerging market debt has done a very good job in the past decade. And we still believe that emerging market debt offers great value. You know, you go to a place like Brazil, when interest rates are peaking at 15%, we have a real rate of 10. Well, you know, real rates of 10, I think that's a big thing. But I think on emerging market debt, definitely, I think we are all in, especially in Latin America. And in Asia, we think that Asia is the place to be for stocks. You have high productivity, low inflation, high growth. But again, we have to go country by country, company by company. Looking at emerging markets as a whole probably doesn't make a lot of sense. But it's the first time in a long time where we like both equities and emerging market debt. And at the top of that, the dollar has to be weaker and there shouldn't be an escalation in the trading world. If these two conditions are met, I think the emerging market can do very well in the next few years.

James: Do you have a favorite commodity to invest in besides gold?

Luca: I think that copper, I think, you know, what's going on in the next five years is that would be. At Recovery Manufacturing. I think that, again, I don't think that the solution of any problem for the global economy, but for a number of reasons, I think almost every government wants to boost their manufacturing sectors. There will be a big spending in infrastructure and there are, you know, analysis from McKinsey and US engineers showing this huge kind of lack of investment in infrastructure, which I think has to be filled at some point. So I think that, and obviously the demand for electrification, I think that industrial metals, copper can do; And what about private markets?

James: So we know private markets have historically done well, especially relative to public markets, but in recent years, maybe not so well. And part of that is because of higher interest rates and more difficult for private companies to borrow.

Luca: Yeah.

James: At this stage, given your view of the world. Do you like private equity better than public equity?

Luca: I have to say that we like private debt more than private equities. I think we are expecting private equities and debt to outperform their public peers, but not by a wide margin. And then obviously open the question is how to invest. Because for us, what is critical more than ever is to be the right manager in the right sector. We like more, for example, private asset in Europe than the US, where valuation is more attractive. But the reason for me really here, the gap between, let's say, the top performer and the bottom performer, for example, in the private equity funds is massive. Private debt, I feel there is more to it because we expect bond yields to fall in a way. So, it's more for us. Bear in mind that we think that a fixed income part of the market will do relatively better than equities in the next few years. So, we have a national bias in favor of bonds. So, yeah, I think our view is that keep what you have. I don't think it's probably now the right time to significantly improve or raise the weights in private assets. Basically, to get cheap financing and buy on the cheap; both parts of the equation are not as good as they were a few years ago. They will still I think outperform but a much less margin than they used to be in the last couple of decades apart from the last few years that obviously has been different.

James: What about real estate?

Luca: Again, you have to go country by country. What I know is that this is a sector that is relatively limited supply and very dependent on real interest rates. I think that real interest rates are going to fall, especially in the US. There are some parts of the market that are probably still relatively bubbly, you know, when we talk about, you know, industrial, you know, and, you know, all these things. Or if you look at office. Yes, there is a kind of potential recovery. I still believe that the scars of COVID will stay there for longer. So, I think an area that could be interesting is more the hotel space, all these kind of things. Residential, again, you have to go one by one. For example, in London, it's interesting that you have a significant decline of the prime property. It's incredible the decline of prime property in central London. They're down almost 30% in a few years.

James: Luca, it's been great to catch up, but before we go, I want to ask you one final thing. If you would leave us with what you think is an emerging theme that at this point is probably not well recognized, and also what your best idea is.

Luca: Well, in terms of teams, there is something I would tell you something which regards. Let's say, the financial industry overall more than an asset class, which is the tokenization. Tokenization, I think, will become very, very popular; it will make a lot of asset classes that are very liquid, difficult to own, you know, would be investable for a lot of people. It's absolutely amazing what tokenization can do for the democratization, if you want, of the investment or the investment opportunities. And the second question, what I liked the most, was it? Yes, best ideas, yeah. The best ideas for us is corporate bonds. And I know that corporate bonds over the long term are the asset class that is an average between basically government bonds and equities. And the reason, so being an average, they're never the best asset class, but are never the worst. I think what I like about them is that you have falling interest rates, low default rates, so you have a strong balance sheet, you have a little bit of everything.

James: Luca, thanks so much for sharing your thoughts with us. Thank you.

Luca: Thank you for having me.

Caroline:  Thanks to both of you. That's a terrific discussion. I particularly love the point about tokenization. That's a really big theme. So thanks for covering that. Thanks, James, for moderating. And Luca, thanks for bringing your insights to us today. Very powerful. Thanks for taking the time to speak to our viewers. And thanks to our viewers for taking time to listen to our Monday Minute today.

Luca: Thank you.