The risk to American exceptionalism

Can innovation strength counter homegrown policy chaos?

There was a time when the term “exceptionalism” was unquestionably seen as positive. Today, one wonders if “American exceptionalism” is still an uplifting expression of freedom and prosperity, or has it become a pejorative pointing to the end of America’s ability to deliver superior investment returns? Might the time have arrived for other countries and regions, for example Europe, to outperform?

Below, we note that for all the present-day angst, America’s fundamental strengths to innovate remain intact. We believe those advantages bode well for potentially sustained superior investment performance, but only if investors maintain faith in the institutions that support the world’s most dynamic economy. That said, changes underway elsewhere, above all fiscal and monetary expansion in the European Union coupled with a strong impetus for capital spending, are changing the focus of return opportunities quite independently of what is happening in the United States.

American exceptionalism

For investors, American exceptionalism refers to the country’s extraordinary economic, institutional, technological, and financial attributes that have helped deliver superior investment returns this century. For even longer, the United States has delivered stronger real gross domestic product growth, higher profitability and greater technological innovation than other economies, offering investors a stellar list of the world’s most successful companies.

The United States also offers the world’s most sought-after currency for payments and savings, alongside the world’s largest and most liquid capital markets. The United States has also led the way in offering investors innovative opportunities in private equity, private credit, venture capital, and real estate. No other country can match U.S .capital markets for the breadth of opportunity.

U.S. innovation has paid great dividends. Since the beginning of 2009, post-global financial crisis, the S&P 500 Index has delivered annualized returns of nearly 14%, easily outpacing the MSCI EAFE Index’s 6% return.¹ That’s a whopping annual average superior return of 8% per annum.

One-third of U.S. equity market outperformance has been due to faster revenue growth and rising profit margins, with two-thirds coming from rising relative valuations. While some may question the sustainability of valuation differentials, the U.S. premium multiple surely reflects investor confidence in the sustainability of superior U.S. profitability.

The U.S. fixed income return advantage has been smaller, but nevertheless persistent. U.S. Treasury yields have typically averaged 2%-3% higher real annual returns (i.e., after adjusting for inflation) than those of Germany’s or Japan’s. Insofar as real yields gravitate toward the potential real rate of economic growth, higher real returns on U.S. bonds reflect higher trend growth.

Is American exceptionalism now at risk?

But so far this year, U.S. returns on stocks and bonds, measured in common currency terms, have lagged, raising questions about whether the United States can retain its preeminent position in global markets.

To some extent, moves underway this year reflect warranted catch-up. After years of U.S. outperformance, investors have underinvested in other markets. Spurred by monetary and fiscal easing and more attractive valuations in Europe, equity portfolio flows have shifted in 2025, propelling European shares higher and the U.S. dollar lower in foreign-exchange markets.

But those moves are mostly tactical or, at best, cyclical. There is little evidence pointing to improved secular returns in Europe (or other markets).

Rather, if American exceptionalism is at risk, the problems are homegrown.

On the positive side, the Trump Administration, supported by majorities in Congress, has introduced various business-friendly deregulation and tax policies. Those policies are likely to underpin higher rising business investment, which typically foreshadows rising productivity and profitability.

But there are negative developments: Tariffs are taxes, which may slow demand via lost purchasing power and compress profit margins. They reshore production, shifting and temporarily disrupting supply lines. It takes time and investment expense to onshore production so that it does not impair long-term profitability.

Large budget deficits, now enshrined in legislation, represent further sources of concern. While fiscal deficits may not yet be reflected in U.S. Treasury yields, fiscal concerns may be contributing to the weakness of the U.S. dollar and higher rates.

Equally, the potential erosion of confidence in the independence of the Federal Reserve to conduct monetary policy could one day impose costly risk premiums on U.S assets, which could undermine the ability of the U.S to deliver sustained exceptional investment returns.

Summary

Innovation is the lifeblood of productivity, growth, and profitability – the underpinnings of durable investment outperformance. But innovation alone will not fully counter outcomes which could undermine confidence in sound fiscal and monetary policies. Over time, we believe American exceptionalism requires both the innate strengths of U.S. innovation and the sound foundations of fiscal and monetary policy. Only then can economic freedom flourish and investors reap rewards.

Michael Browne is Global Investment Strategist for the Franklin Templeton Investment Institute of Franklin Templeton. This article was originally published on the Franklin Templeton Institute’s “Insights” page.

Notes

1. Source: Bloomberg. As of July 31, 2025. The MSCI EAFE Index measures the performance of large- and mid-cap stocks across 21 developed markets in Europe, Australasia and the Far East, explicitly excluding the United States and Canada. Past performance is not an indicator or a guarantee of future performance. Indexes are unmanaged and one cannot invest directly in an index. Important data provider notices and terms available at www.franklintempletondatasources.com.

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