Thoughts on the Market

How Waning American Dominance Could Move Yields

July 31, 2025

How Waning American Dominance Could Move Yields

July 31, 2025

Lisa Shalett, our Wealth Management CIO, and Andrew Sheets, our Head of Corporate Credit Research, conclude their discussion of American Exceptionalism, factoring in fixed income, in the second of a two-part episode.

Transcript

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

 

Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

 

Andrew Sheets: Today a today a concluding look at the theme of American exceptionalism and how it factors into fixed income.

 

It's Thursday, July 31st at 4pm in London.

 

Lisa Shalett:  And it's 11am here in New York.

 

So, Andrew, it's my turn to ask you some questions. And yesterday we talked a lot about equity markets, globalization, some of the broader macro shifts. , But I wanted to zoom in on the credit markets today and one of our themes in, in the American Exceptionalism paper was the constraints of debts and deficits and how they play in. With U.S. debts level soaring and interest costs rising, how concerned should investors be?

 

Andrew Sheets: So, you alluded to this a bit on our discussion yesterday that we are in a very interesting divide where you have, inequality between very well-off companies and weaker companies that aren't doing as well. You have a lot of division within households between those who are,  doing better and struggling more with the rate environment.

 

But you know, I think we also see that the large deficits that the U.S. Federal government are running are in some ways largely mirrored by very, very good private sector financial positions. In aggregate U.S. households have record levels of assets relative to debt at the end of 2024, in aggregate the financial position of the U.S. equity market has never been better.

 

And so, this is a dynamic where lending to the private sector, whether that is to parts of the residential mortgage market or to the corporate credit market, does have some advantages; where not just are you dealing with arguably a better trend of financial position, but you're just getting less issuance.

 

I think there are a number of factors that could cause the market to cause the difference of yield between the government debt and that private sector debt – that so-called spread – to be narrower than it otherwise would be.

 

Lisa Shalett: Well, that's a pretty interesting and provocative idea because, one of the, the hypotheses that we laid out in our paper is that perhaps one of the consequences of this extraordinary period of monetary stimulus of financial repression and ultra low rates, , of massive regulation of the systemically important banking system, has been the explosion of shadow banks, and the private credit markets. Our thesis is, they're a misallocation of capital. Has there been excess risk taking? And in that area. And how should we think about that asset class, number one? And,  number two, , are they increasingly, a source of. liquidity and issuance, or are they a drain on the system?

 

Andrew Sheets: This is, kind of, where your discussion of normalization is is so interesting because, in aggregate household balance sheets are in very good shape; in aggregate corporate balance sheets are in very good shape. But I do think there's a distinct tail of the market. , it's call it 5 percent of the high yield market, where you really are looking at a corporate capital structure that was designed for for a much lower level of rates. It was designed for maybe a immediately post COVID environment where rates were on the floor and expected to stay there for a long period of time.

 

And so, if we are moving to an environment where Fed funds is at 3 or 4. Or as you mentioned – hey, maybe you could justify a rate even a little bit higher and not be wildly off. Well then, you just have the wrong capital structure. You have the wrong level of leverage; and it's actually hard to do much about that other than to restructure that debt, or look to change it in a larger way.

 

So, I think we'll see a dynamic similar to the equity market where there is less dispersion between the haves and have nots.

 

Lisa Shalett: As we kind of think about where there could be pockets of opportunity in, in credit and in private credit, both public and private credit, , and where there could be risks. Can you just help me with that and explore that a little bit more?

 

Andrew Sheets: I think where credit looks most interesting is in some ways where it looks most boring. I think where the case for credit is strongest is – the investment grade market in the U.S. pays, 5.25 percent.

 

A 6 percent long run return might be competitive with certain investors’ long-term equity market forecasts, or at least not a million miles off.

 

I think though the other area where this is going to be interesting is. Do we see significantly more capital intensity out of the tech sector, And a real divide between fixed income and equities is that tech has so far really been an equity story.

 

Lisa Shalett: Correct.

 

But this data center build out is just enormous. I mean, through 2028, our analysts at Morgan Stanley think it's close to $3 trillion with a t.

 

And so there's a lot of interest in, in how can credit markets, how can private credit markets fund, , some of this build out and,  there are opportunities , and risks around that.

 

And you know, something that I think credit's going to play an interesting part of.

 

Lisa Shalett: And in that vision do you see the blurring of lines or a more competitive market between public and private?

 

Andrew Sheets: I do think there's always a little bit of a funny nature about credit where I. it's not always clear why a particular corporate loan would need to be traded every day, would need to be marked every day. I think it is a little bit different from the equity market in that way.

 

And I think you're also seeing a level of sophistication from investors who now have the ability to traffic across these markets and move capital between these markets, depending on where they think they're being better compensated or, or where there's better opportunities. So, I think we're kind of absolutely seeing the blur of these lines.

 

And again, I think private credit, , has until recently been somewhat synonymous with high-yield lending, riskier lending, lower rated lending.

 

Lisa Shalett: Correct. Yeah.

 

Andrew Sheets: And,  yet, the lending that we're seeing to some of this tech infrastructure is, you could argue, maybe more similar to Investment Grade lending – both in terms of risk, but also it pays a lot less. ,  And so again, this is kind of an interesting transition where you're seeing a, a broader scope and absolutely, I think more blurring of the line between these markets.

 

Lisa Shalett: So, let's just switch gears a little bit and pull out from credit to the broader diversified cross-asset portfolio. And some of those cross-asset correlations are starting to break down; and we go through these periods where stocks and bonds are more often than not positively correlated in moving together.

 

How are you beginning to think about duration risk in this environment? And have you made any adjustments to how you think about portfolio construction in light of, , these potentially, , shifting, , changes in correlations across assets?

Andrew Sheets:  I think there are kind of maybe two large takeaways I would take from this. First is I do think the big asset where we've seen the biggest change is in the U.S. dollar. The U.S. dollar, I think for a lot of the period we've been discussing on these two episodes, was kind of the best of both worlds. And recently that's just really broken down.

 

And so, I think when we think about the reallocation to the rest of the world, the, the focus on diversification, I think this is absolutely something that is top of mind among non-U.S. investors that we're talking to, which is almost the U.S. equity piece is kind of a separate conversation.

 

Andrew Sheets: The other piece though, is some of this debate around yields and equities – and do equities fear higher rates or lower rates?

 

Which one of those is the biggest problem? And there's a question of magnitude that's a little interesting here. Rates going higher might be a little bit more of a problem for the S&P 500 than rates going lower.

 

That rates going higher might be more consistent with the scenario of temporary higher inflation. Maybe rates go lower [be]cause the market gets more excited about Federal Reserve cuts.

 

But I think in terms of scenarios where – like where is the equity market really going to have a problem? Well, it's really going to have a problem if there's a recession.

 

So, even though I think bonds have been less effective diversifiers, , I really do think they're still going to serve a very healthy, helpful purpose around some of those potentially kind of bigger dynamics.  

 

Lisa Shalett: Yeah that very much the way we've been thinking about it, , particularly within the, the context of, of managing private wealth, where, , very often we're confronted with the, the question, what about 60-40? Is 60-40 dead? Is 60-40 back? Like, you talk about not wanting to hedge, I don't want to hedge, , either. But, but the answer to the question we agree is, is somewhat nuanced. Right?

 

We do agree that, this perfect world of, negative correlations between stocks and bonds that we enjoyed, , for a good portion of the last 15 years probably is over. . But that doesn't mean that bonds , and most specifically, that five to 10 year part of the curve doesn't have a really important role to play in portfolios.

 

And the reason I say that, , is that one of the other elements of this conversation that we haven't really touched on, , is valuation and expected returns.

 

I know that when I speak of the valuation-oriented topics and the CAPE ratio when expected 10-year returns, everyone's eyes glaze over and roll to the back of their head and they say, ‘Oh, here she goes again.’ , But look, I, I am in the camp that says an awful lot of growth has already been discounted and already been priced. And that it is much more likely that U.S. equities will return something closer to long run averages. So that's not awful.

 

The lower volatility of a, fixed income asset that's returning sixes and sevens has a definite role to play in portfolios for wealth clients who are by and large long term oriented investors who are not necessarily attempting to exploit, , 90-day volatility every quarter.

 

Andrew Sheets:   Without putting too fine of a point on it, I think when that question of is 60-40 over is phrased, I kind of think the subtext is often that it's the bond side, the 40 side that has a problem. And not to be the fixed income defender on this podcast, but you could probably more easily argue that if we're talking about, well, which valuation is more stretched, the equity side or the bond side. I think it's the equity side that has a more stretched valuation.

 

Lisa Shalett: Without a doubt, without a doubt.

 

Andrew Sheets:  Well, Lisa, thanks again for taking the time to talk.

 

Lisa Shalett: Absolutely great to speak with you, Andrew, as always.

 

Andrew Sheets: And thanks again for listening to this two-part conversation on American exceptionalism, the changes coming to that and how investors should position. And to our listeners, a reminder to take a moment to please review us wherever you listen. It helps more people find the show. And if you found this conversation insightful, tell a friend or colleague about Thoughts on the Market today.

Hosted By
  • Andrew Sheets
Guests
  • Lisa Shalett

Thoughts on the Market

Listen to our financial podcast, featuring perspectives from leaders within Morgan Stanley and their perspectives on the forces shaping markets today.

Up Next

In the first of a two-part episode, Lisa Shalett, our Wealth Management CIO, and Andrew Sheets, our Head of Corporate Credit Research, discuss whether the era of “American Exceptionalism” is ending and how investors should prepare for a global market rebalancing. 

Transcript

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

 

Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

 

Andrew Sheets: Today, the first of two episodes tackling a fascinating and complex question. Is American market dominance ending? And what would that mean for investors?

It's Wednesday, July 30th at 4pm in London.

 

Lisa Shalett: And it's 11am here in New York.

 

Andrew Sheets: Lisa, it's so great to talk to you again, and especially what we're going to talk about over these two episodes. , a theme that's been coming up regularly on this podcast is this idea of American exceptionalism. This multi-year, almost multi-decade outperformance of the U.S. economy, of the U.S. currency, of the U.S. stock market.

 

And so, it's great to have you on the show, given that you've recently published on this topic in a special report, very topically titled American Exceptionalism: Navigating the Great Rebalancing.

So, what are the key pillars behind this idea and why do you think it's so important?

 

Lisa Shalett: Yeah. So, , I think that that when you think about the thesis of American exceptionalism and the duration of time that the thesis has endured. I think a lot of investors have come to the conclusion that many of the underpinnings of America's performance are just absolutely inherent and foundational, right?

 

They'll point to America as a, economy of innovation. A market with regulation and capital markets breadth and depth and liquidity a market guided by, , laws and regulation, and a market where, , heretofore we've had relatively decent population growth.

 

All things that tend to lead to growth. , But our analysis of the past 15 years, while acknowledging all of those foundational pillars say, ‘Wait a minute, let's separate the wheat from the chaff.’ Because this past 15 years has been, extraordinary and different. And it's been extraordinary and different on at least three dimensions.

 

One, the degree to which we've had monetary accommodation and an extraordinary responsiveness of the Fed to any crisis. Secondly, extraordinary fiscal  policy and fiscal stimulus. And third, the, the peak of globalization a trend that in our humble opinion, American companies were among, , the biggest beneficiaries of exploiting, despite all of the, political rhetoric that considers the costs of that globalization.

 

Andrew Sheets: So, Lisa, let me go back then to the title of your report, which is the Great Rebalancing or navigating the Great Rebalancing. So, what is that rebalancing? What do you think kind of might be in store going forward?

 

Lisa Shalett: The profound out performance, as you noted, Andrew, of both the U.S. dollar and , American stock markets have left the world, , at an extraordinarily overweight position to the dollar and to American assets.

And that's against a backdrop where, , we're a fraction of the population. We're 25 percent, , of global GDP, and even with all of our great companies, we're still only 33 percent of the profit pool. So, we were at a place where not only was everyone overweight, but the relative valuation premia of American equity assets versus, , equities outside or rest of world was literally a 50 percent premium.

 

And that really had us asking the question, is that really sustainable? Those kind of valuation premiums – at a point when all of these pillars, fiscal stimulus, monetary stimulus, globalization, are at these profound inflection points.

 

Andrew Sheets: You mentioned monetary and fiscal policy a bit as being key to supercharging U.S. markets. Where do you think these factors are going to move in the future, and how do you think that affects this rebalancing idea?

 

Lisa Shalett: Look, I mean, I think we went through a period of time where on a relative basis, relative growth, relative rate spreads, right? The, the dispersion between what you could earn in U.S. assets and what you could earn, , in other places, and the hedging ratio in those currency markets, , made owning U.S. assets, , just incredibly attractive on a relative basis.

 

As the U.S. now kind of hits this point of inflection when the rest of the world is starting to say, okay, in an America first and an America only policy world, what am I going to do?

 

And I think the responses are that for many other countries, they are going to invest aggressively . in defense, in infrastructure, in technology, , to, , respond to de-globalization, if you will.

 

And I think for many of those economies, it's going to help equalize not only growth rates between the U.S. and the rest of the world, but it's going to help equalize, , rate differentials. Particularly on the longer end of the curves, where everyone is going to spending money.

 

Andrew Sheets: That's actually a great segue into this idea of globalization, which again was a major tailwind for U.S. corporations and a pillar of this American outperformance over a number of years.

It does seem like that landscape has really changed over the last couple of decades, and yet going forward, it looks like it's going to change again. So, with rising deglobalization with higher tariffs, what do you think that's going to mean to U.S. corporate margins and global supply chains?

 

Lisa Shalett: Maybe I am, , a product of, my training  and economics, but I have always been a believer in comparative advantage and what globalization allowed. True free trade and globalization of supply chains allowed was for countries to exploit what they were best at – whether it was the lowest cost labor, the lowest cost of natural resources, the lowest cost inputs. , And America was aggressive at pursuing those things, at outsourcing what they could, , to grow profit margins. And, , that had lots of implications.

 

And we weren't holding manufacturing assets or logistical assets or transportation assets necessarily, , on our balance sheets.

 

And, , that dimension of this asset light and optimized supply chains, , is something in a world of tariffs, in a world of deglobalization, in a world of create manufacturing jobs onshore, , where that gets reversed a bit. And there's going to be a, a financial cost to that.

 

Andrew Sheets: It's probably fair to say that the way that a lot of people experience American exceptionalism is in their retirement account.

 

In your view, is this outperformance sustainable or do you think, as you mentioned, changing fiscal dynamics, changing trade dynamics, that we're also going to see a leadership rotation here?

 

Lisa Shalett: Our thesis has been, , this isn't the end of American exceptionalism. , point blank, black and white. What we've said, however, is that we think that the order of magnitude of that outperformance is what's going to close, , when you start burdening, , your growth rate with headwinds, right?

 

And so, again, not to say that that American assets can't continue to, to be major contributors in portfolios and may even, , outperform by a bit. But I don't think that they're going to be outperforming by, , the magnitude, kind of the 450 - 550 basis points per year compound for 15 years that we've seen.

 

Andrew Sheets: The American exceptionalism that we've seen really since 2009, it's also been accompanied by really unprecedented market imbalances. But another dimension of these imbalances is social and economic inequality, which is creating structural, and policy, and political challenges.

 

Do these imbalances matter for markets? And do you think these imbalances affect economic stability and overall market performance?

 

Lisa Shalett: People need to understand what has happened over this period. When we applied this degree of monetary and fiscal, stimulus, what we essentially did was massively deleverage the private sector of America, right?

 

And as a result, , when you do that, , you enable and create the backdrop, , for the portions of your economy who are less interest rate sensitive, , to continue to, , kind of invest free money. And so, , what we have seen is that this gap between the haves and the have nots, those who are  most interest rate sensitive and those who are least interest rate sensitive – that chasm is really, , blown out.

 

But also I would suggest an A economic policy conundrum. We can all have points of view about the central bank, and we can all have points of view about the current chair. , But the reality is if you look at these dispersions in the United States, you have to ask yourself the question, is there one central bank policy that's right for the U.S. economy?

 

I could make the argument that the U.S. GDP, right, is growing at 5.5 percent nominal right now. And the policy rate's 4.3 percent. Is that tight?

Andrew Sheets: Hmm.

 

Lisa Shalett: I don't know, right? The economists will tell me it's really tight, Lisa – [be]cause neutral is 3. But I don't know. I don't see the constraints. If I drill down and do I say, can I see constraints among small businesses?

 

Yeah. I think they're suffering. Do I see constraints in some of the portfolio companies of private equity? Are they suffering? Yeah. Do they need lower rates? Yeah. Do the lower two-thirds of American consumers need lower rates to access the housing market. Yeah.

 

But is it hurting the aggregate U.S. economy? Mm, I don't know; hard to convince me.

 

Andrew Sheets: Well, Lisa, that seems like a great place to actually end it for now and Thanks as always, for taking the time to talk.

 

 

Lisa Shalett: My pleasure, Andrew.

 

Andrew Sheets: And that brings us to the end of part one of this two-part look at American exceptionalism and the impact on equity and fixed income markets. Tomorrow we'll dig into the fixed income side of that debate.

Thank you as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today. 

TotM

AI adoption, dollar weakness and tax savings from the Big Beautiful Bill are some of the factors boosting our CIO and Chief U.S. Equity Strategist Mike Wilson’s confidence in U.S. stocks. 

Transcript

Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S.  Equity Strategist. Today on the podcast I will discuss what's driving my optimism on stocks.

 

It's Tuesday, July 29th at 11:30am in New York. 

 

So, let’s get after it.

 

Over the past few weeks, I have been leaning more toward our bull case of 7200 for the S&P 500 by the middle of next year. This view is largely based on a more resilient earnings and cash flow backdrop than anticipated. The drivers are numerous and include positive operating leverage, AI adoption, dollar weakness, cash tax savings from the Big Beautiful Bill, and easy growth comparisons and pent-up demand for many sectors in the market.

 

While many are still focused on tariffs as a headwind to growth, our analysis shows that tariff cost exposures for S&P 500 industry groups is fairly contained given the countries in scope and the exemptions that are still in place from the USMCA. Meanwhile, deals are being signed with our largest trading partners like Japan and Europe that appear favorable to the U.S.

 

Due to the lack of pricing power, the main area of risk in the stock market from tariffs is consumer goods; and that’s why we remain underweight that sector. However, the main tariff takeaway for investors is that the rate of change on policy uncertainty peaked in early April. This is the primary reason why earnings guidance bottomed in April as evidenced by the significant inflection higher in earnings revisions breadth—the key fundamental factor that we have been focused on.

 

Of course, the near-term set up is not without risks. These include still high long-term interest rates, tariff-related inflation and potential margin pressure. As a result, a correction is possible during the seasonally weak third quarter, but pull-backs should be shallow and bought. In addition to the growth tailwinds already cited, it’s worth pointing out that many companies also face very easy growth comparisons.

 

I’ve had a long standing out of consensus view that the U.S. has been experiencing a rolling recession for the last three years. This fits with the fact that much of the soft economic data that has been hovering in recession territory for much of that period as well—things like purchasing manager indices, consumer confidence, and the private labor market. It also aligns with my long-standing view that government spending has helped to keep the headline economic growth statistics strong, while much of the private sector and many consumers have been crowded out by that heavy spending which has also kept the Fed too tight.

 

Meanwhile, private sector wage growth has been in a steady decline over the last several years, and payroll growth across Tech, Financials and Business Services has been negative – until recently. Conversely, Government and Education/Health Services payroll growth has been much stronger over this time horizon. This type of wage growth and sluggish payroll growth in the private sector is typical of an early cycle backdrop. It's a key reason why operating leverage inflects in early cycle environments, and margins expand. Our earnings model is picking up on this underappreciated dynamic, and AI adoption is likely to accelerate this phenomenon. In short, this is looking more and more like an early cycle set up where leaner cost structures drive positive operating leverage after an extended period of wage growth consolidation.

 

Bottom line, the capitulatory price action and earnings estimate cuts we saw in April of this year around Liberation Day represented the end of a rolling recession that began in 2022. Markets bottom on bad news and we are transitioning from that rolling earnings recession backdrop to a rolling recovery environment.

 

The combination of positive earnings and cash flow drivers with the easy growth comparisons fostered by the rolling EPS recession and the high probability of the Fed re-starting the cutting cycle by the first quarter of next year should facilitate this transition. The upward inflection we're seeing in earnings revisions breadth confirms this process is well underway and suggests returns for the average stock are likely to be strong over the next 12-months. In short, buy any dips that may occur in the seasonally weak quarter of the year.

 

Thanks for tuning in; I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out!

 

TotM

More Insights