How the end of the ‘American exceptionalism’ trade is rippling around the globe

The superior performance of U.S. investments over the past decade-plus has been a giant magnet for the world’s money. Foreign investors own almost 20% of all U.S. equities compared with 7% at the start of this century, Goldman Sachs data shows. The bets generated years of windfall profits, making up for dreary returns on offer in many overseas markets.

Now, foreigners are racking up losses as the so-called American exceptionalism trade sputters. The Trump administration’s tariff whiplash, doubts about the U.S. artificial-intelligence trade, and recession fears have rattled U.S. markets this year, even as European ones have rallied.

The selloff could prove temporary. But it is stoking concern that if U.S. markets really were to crater, the collateral damage would be profound.

“You’ve got an enormous global concentration in U.S. financial markets," said Brad Setser, senior fellow at the Council on Foreign Relations and a former U.S. Treasury Department official. “Investors are taking an increasingly big risk."

Overseas investors are more vulnerable to U.S. market turbulence because of their exposure to the dollar. The S&P 500 is down about 9% from its February peak, but eurozone investors have lost about 13% due to the dollar’s slide, according to FactSet data.

“Looking back in history at episodes when concentration was so high, it always ends," said Torsten Slok, chief economist at Apollo Global Management. “The finance textbook is clear: You should simply not allow your U.S. share to grow so big."

The large presence of the U.S. in global portfolios is a byproduct of years of measly returns abroad—and huge success in America, thanks to fast economic growth, thick profit margins, and innovative tech companies such as Apple and Nvidia. The U.K.’s FTSE 100 index is up less than 30% over the past decade. The S&P 500, even after this year’s selloff, is up more than 170%.

The rise of passive investing, in which funds track a broad market index, also plays a role. As U.S. markets have grown so has their share in indexes, creating built-in demand for American assets.

U.S. stocks make up 72% of MSCI’s index of international stocks, a benchmark for many global portfolios. That is up from about 47% in 2008. American debt’s share in global bond benchmarks also has shot higher.

In one of London’s poshest areas, the Royal Borough of Kensington and Chelsea, the local government’s pension fund has enough money to pay out all its obligations two times over thanks largely to U.S. stocks.

In New Zealand, the pension fund for Anglican Church clergy notched a 27% increase on its international stock portfolio in its last fiscal year. Norway’s $1.8 trillion oil-wealth fund posted its largest-ever profit thanks to “massive gains" on its tech portfolio, according to Nicolai Tangen, chief executive of Norges Bank Investment Management, which operates the fund.

“We are very happy shareholders in great American companies. For the last 10 years, the U.S. has compounded at twice the rate of Europe," Tangen said.

He and others have concerns, however, especially about the market’s reliance on U.S. tech. Previous U.S. financial-market downturns were global events. The 2008-09 subprime mortgage crisis ricocheted across the global financial system, and the dot-com crash in the early 2000s fueled recessions in economies such as Taiwan’s that had built up large tech sectors.

Norway’s fund has trimmed U.S. tech holdings, but its overall exposure to the U.S. has been rising because of a government decision to put more money in America. U.S. assets made up 53% of the fund’s investments last year, up from 32% a decade earlier. It can deviate only slightly from its benchmarks, which are largely dominated by U.S. assets.

The fund’s latest stress-test scenario showed it could lose 18% of its value if the AI boom turns to bust. The wealth fund contributes about 20% of Norway’s government budget and helps pay for its generous social-welfare programs.

Individual investors have piled in, too. Trading apps have opened up U.S. markets to investors in Europe, where people traditionally stashed savings in cash, bank accounts and insurance policies. The most popular stocks on European trading app Trade Republic last year were Nvidia, Apple and Amazon.

Omer Martinet, 29 years old, of Bordeaux, France, started investing in 2020 and now holds 70% of his stock portfolio in U.S. companies.

“I compared the performance of French companies to U.S. companies, and the difference was astonishing," he said.

Martinet, who is up overall on his investments, said he had lost “tens of thousands of euros" this year because of the U.S. market selloff. If they don’t recover, he might have to delay his plan to buy an apartment. But he isn’t giving up on his U.S. investments.

“I think the U.S. economy will remain, for at least this century, the main economy in the world," he said.

The dollar has weakened this year. A further selloff is a threat to overseas investors, who owned more than $14 trillion in U.S. bonds at the end of 2024, according to Federal Reserve data. Many only partially shield themselves against currency swings, a practice known as hedging.

Taiwanese life insurers are among the most exposed, said Setser of the Council on Foreign Relations. They own more than $700 billion in foreign bonds, he said, mainly U.S. dollar debt. Most of their liabilities are in Taiwan dollars. About 40% of this currency mismatch isn’t hedged.

Many foreign investors say the U.S. still has more to offer than much of the rest of the world. Australia’s largest pension fund, AustralianSuper, has about a third of its $230 billion in assets in the U.S. and is expanding its New York office. John Normand, head of investment strategy, expects the U.S. market turbulence will be temporary.

“The U.S. is first in the league table for interesting investment opportunities that meet all of our criteria: scale, scope, cyclical strength, structural strength," Normand said. “The U.S. is going to have certain advantages for a while."

Write to Chelsey Dulaney at chelsey.dulaney@wsj.com