How to invest for the ‘great rebalancing’

“American Exceptionalism,” the belief among many investors that the US economy and markets are fundamentally stronger than those of other global regions, has been a powerful driver of outsized US equity returns for many years now.

In fact, since the 2007-2009 global financial crisis, US equities have outpaced developed market international stocks by a stunning 430% cumulatively. This kind of dominance has led to the US taking up an increasingly large share of global equity indexes. Today, US stocks account for 64% of global market capitalization, despite the US having just 4% of the world’s population and 25% of global gross domestic product (GDP).

But now, a host of challenges, such as shifting trade policies and swelling US government debt, are adding uncertainty to the outlook, and many investors are asking: Is the era of American Exceptionalism ending?

Morgan Stanley’s Global Investment Committee does not believe it is. Nor do we think the long-running bull market in US equities is doomed. However, we do see US markets entering a far more challenging period of normalization and global rebalancing, with significant implications for asset allocation and portfolio construction for investors in the years ahead.

For more than 15 years, the US economy has far exceeded most global rivals in growth, productivity, the pace of innovation and corporate profitability. In financial markets, the US-based mega-cap tech stocks are dominant, cash-rich and profitable, with few obvious global substitutes.

But history shows that such market dominance is rarely permanent. The same policy actions that supercharged US financial performance since the global financial crisis are now unwinding, which will likely remove key tailwinds for US markets. In particular, we see three major factors at inflection points:

The extraordinary monetary policy responses to the financial crisis and the COVID-19 pandemic injected trillions of dollars into the economy and kept interest rates low. With ample money flowing through the system, financial returns were increasingly driven by rising valuation multiples, or the price investors would pay for an asset relative to its earnings, which grew increasingly disconnected from the real economy.

Now, with such accommodative monetary policy unlikely to be replicated, we see rates normalizing back to higher long-term levels, likely creating a ceiling for valuations.

By injecting trillions of dollars into the economy, policymakers in Washington have helped households and businesses shore up their balance sheets over the past 15 years. However, that required immense federal spending and borrowing. As a result, the US budget deficit has grown to nearly double the 80-year average and the debt-to-GDP ratio, at 120%, is near its highest level in more than 60 years, raising concerns about the long-term sustainability of US government finances.

With borrowing costs on the rise, interest payments now account for a greater share of federal outlays, exceeding even national defense spending. This risks crowding out any potential federal discretionary spending or fiscal stimulus during the next recession or other crises. A higher cost of capital also risks constraining private-sector investment and weighing on asset prices in financial markets.

Globalization provided US companies with access to low-cost labor and materials that helped reduce expenses and grow profit margins. It also allowed the US to shift away from manufacturing to a profitable services- and innovation-led economy. And it provided American companies with greater access to non-US markets, which currently account for more than one-third of S&P 500 profits.

However, the US’s current pursuit of a deglobalization-oriented policy could lead to inefficiencies, lower corporate profit margins and potentially higher inflation, while also weakening the US dollar relative to other global currencies.

Investors need to be prepared for a more challenging period in which US economic dominance could recede and the strength of global markets comes back into balance – what we call the “Great Rebalancing.” This new era will likely be characterized by higher interest rates, greater volatility and a weaker dollar, which could shift capital flows toward non-US markets.

Think of it as the popular investing dynamic of the past 15 years getting flipped on its head – from the passive, US growth-only portfolio, often enhanced by exceptional returns to private assets, to the actively-managed, global, value-oriented portfolio with more opportunities in public securities.

Against this backdrop, investors may consider updating portfolios to include:

• More comprehensive sector, asset-class and regional diversification.
• Relative value opportunities outside the US, including in India, Japan, Brazil and Mexico, which may benefit from efforts to shore up global supply chains.
• Global financials and other cyclical industries like energy, materials, industrials and automation, which could benefit from a steeper yield curve and lower inflation outside the US.
• Real assets and hedge funds, which may prove attractive amid potentially higher stock-specific risk, volatility and US policy constraints.

This article is based on the Morgan Stanley Global Investment Committee Special Report from July 7, 2025, “American Exceptionalism: Navigating the Great Rebalancing.”

When considering which investments may fit into your portfolio, be sure to keep in mind individual goals, timelines, and risk tolerance.

Wondering how you can align your investments with economic and market trends like the ones discussed in this report? Check out these themes and explore related exchange-traded funds (ETFs).

You may also want to consider learning more about how options or futures could help you navigate today’s markets. Adding futures to your trading strategy can offer unique opportunities to help diversify across more than 70 asset classes and manage risk, while options could offer the flexibility you need to manage portfolio volatility more effectively. Please note options and futures carry a high degree of risk, and are not suitable for all investors.

CRC# 4726260 08/2025