US stock market slump is bad news for British pensions
By Simon French, Chief Economist and Head of Research
The US stock market, relative to the rest of the world, has had its worst start to the year since 1993. Down 14% since 1 January, global investors have shifted their attention away from the US to more keenly valued markets across Europe, the UK, and Asia which are flat for the year. This is a story of heightened economic uncertainty - amplified by the recent US tariff announcements - as well as US stock market valuations that are widely priced for perfection. Investors are looking for safe harbours whilst the economic storm blows through. Perfection appears like a distant port.
If this was simply a story of economic uncertainty as President Trump’s team tries to reboot America’s terms of trade, then it would be easy to dismiss this as a blip in a long period of US exceptionalism. After all since 2010 the US stock market has delivered a total return for investors of 470%, compared to the rest of the world at a more pedestrian 115%. The US economy has seen its GDP grow by 42% since the end of the Global Financial Crisis, compared to the wider G7 growing by just 16%. It is neither surprising, nor irrational for investors to chase these outsized returns available in the US economy. However the end result is that the US stock market now makes up more than 60% of the global stock market. Passive investment vehicles - ones that simply track the wider market - are therefore heavily exposed to the US economy.
There is little passive in that. The upshot of these trends is that 45% of the total holdings of defined contribution UK pension schemes are in US shares, with a further 7% held in US corporate and government debt. More than half of the wealth tied up to fund Britons’ retirement income is directly linked to the prospects for the US economy.
There are problems, and opportunities with this level of asset exposure. There is an old adage dating back to the Great Depression that if the US economy sneezes the rest of the world catches a cold. If I can update that adage for 2025 I would observe that if the US stock market stumbles, the rest of the world gets heavily bruised. This is the problem with having so much concentration of wealth and savings held in a single market, regardless of its underlying virtues.
But there are also opportunities for the rest of the world. President Trump is focused on the US trade deficit and a persistent current account deficit run by the world’s largest economy. But the mirror of these deficits has been a growing surplus in the US capital account. For a quarter of a century the US economy has been sucking Dollars back in to keep a lid on financing costs for its corporate sector, and to service the huge US federal debt. A debt that now stands at an eyewatering $36 trillion. Should US trade partners choose to retaliate to tariffs, then arguably the less directly inflammatory approach would be to steadily purchase less US debt, and less US equity. The result would be to push up US borrowing costs, and lower the valuations at which US companies can raise equity. Trade wars aren’t always about steel and soyabeans. Often they involve securities.
For many years this retaliatory option has focused the minds of observers of the fractious US-China relationship. Since 2015, Chinese holdings of US government debt have shrunk by half a trillion dollars. Whilst some of this money has shifted into US shares, as well as US agency debt, there is plenty of evidence that China has diversified away from the US amidst incrementally more hostile Sino-American rhetoric. Last week’s multilateral tariff announcement potentially fired the starting gun on more widespread skepticism on the wisdom of capital exposure to the US economy.
The question facing policymakers across the world is how much to let this trend play out as financial market participants draw their own conclusions on the wisdom of US economic policymaking. Alternatively a more proactive approach might be desirable. Whilst the Trump administration rationalize use of tariffs in the pursuit of fair trade, US trade partners may conclude that they need to focus their tax incentives and capital controls to generate a fairer cost of capital. Given the need of many of these economies to fund their own defence and security to a level unimagined for forty years this cost of capital is a key policy consideration.
What does all this mean, practically, for the UK? At present the Labour government is in the middle of a pensions investment review. Part of the strategic question this review should now address is whether UK tax system should remain agnostic to where assets are held, or in the case of stamp duty on UK share transactions – remain openly hostile to UK share ownership?
There is understandable reluctance amongst policymakers to mandate UK asset ownership in pensions. However a series of decisions dating back to the abolition of Dividend Tax Credit in 1998 and widening the eligibility of assets held in a Personal Equity Plan in 2001 – now the Stocks and Shares ISA - appear less attractive in a more fragmented, contestable global economy. An increasingly mercantilist White House poses profound questions on the neutrality of capital flows in the world economy.
President Trump said last week he “hasn’t checked his 401k” – the US default retirement savings account. No-one really believes that. Most seasoned observers suggest that a falling US stock market and a rising cost of US debt is the soft underbelly of this administration. In a trade war thus far focused on tradeable goods, international capital is the likely next battleground.
