Key Highlights

• Q1 earnings expectations have fallen since January, now at 4.5%
• Asset allocation pressure led to stock rotations from the U.S. to Europe and China
• Tariff concerns have left institutional investors on the sidelines amid retail buying

What’s driving growth?

EXHIBIT #1: S&P 500 VS. P/E Q1 AND Q2 OUTLOOKS

^{Source: Bloomberg, BNY}

The most important factor driving equities in the first quarter was growth, not inflation or margins. Stock moves reflected the shift away from the U.S. to the growth prospects in Europe and Asia, with reduced expectations for U.S. GDP. Clarity about tariff risks led to increasing doubts about growth and changing expectations for stock earnings, with the turning point coming with the implementation of steel and aluminum tariffs on February 11.  As equities trading in the first quarter showed, the growth outlook is fundamental for investors. The bottom of bearish trading came on March 13, when a government shutdown was averted after Senate minority leader Schumer opted to support the Republican spending bill. The current market is fairly priced to April 2 expectations for moderate but not extreme tariffs.

EXHIBIT #2 :U.S., GERMANY AND CHINA EQUITY HOLDINGS

^{Source: BNY iFlow}

Our take

According to iFlow data, there was a notable shift in holdings out of U.S. assets and into European and Chinese stocks beginning on January 21 – coinciding with the start of the second Trump presidency and the surprise announcement about Chinese AI engine DeepSeek. Current holdings reflect the U.S. growth mood swing, which is also showing up in surveys of consumer and business sentiment. Overall, holdings are now slightly below the 5-year average by 1 to 2%, with positions most notably sold in U.S. consumer discretionary. The inflow of industrial shares is striking in the U.S. and globally.

Forward look

Markets have not yet priced in a global recovery, choosing instead to adopt a wait-and-see attitude because of tariffs. As a result, there is a not insignificant risk of stock prices remaining high even after implementation of tariffs on April. The relationship of U.S. equities, bonds and the USD will likely be in turmoil as hedging of USD and anticipating sticky inflation should dominate the start of the second quarter.

EXHIBIT #3 : U.S. EQUITY HOLDINGS VS. U.S. 10Y YIELDS

^{Source: Bloomberg, BNY}

Our take

The role played by bonds in asset allocation shifted in Q1. The yield declines we saw in October 2024 following the FOMC’s jumbo rate cuts reversed as it became clear the Fed would pause its rate cuts. The risk that rates will not support U.S. growth became clear in March when the FOMC released its statement and economic projections. There is also a clear divergence between U.S. portfolios with fixed income compared to those in EMEA and APAC. iFlow shows the rate of U.S. equities to bonds is 69% to 31%. This represents an extreme shift in growth expectations in the U.S., with 2025 growth estimates falling from 2.5-3.0% in January to 0.5-1.0% in March, and the odds of a recession climbing from 15% in January to 35% or higher in March. By comparison, the ratio of equities to bonds is closer to 55%/45% in EMEA and 60%/40% in APAC. The U.S. risk of a normalization of bonds remains a consideration for investors, but one that depends on FOMC policy driving growth rather than inflation normalizing.

Forward look

The ETF market highlights the split between the retail and institutional views of the risks as we head into Q2. The retail investor “buy the dip” mentality dominated in March. Rotational effects coupled with correction purchases of U.S. shares sent the equity focused on ETF volumes higher. The trough in markets we saw in early March matches our iFlow Mood Index bottoming out. The lack of interest in fixed income has also led to a shift in credit views. The widening spread of IG credit combined with the ongoing high level of supply in March, at $175bn, has left demand for fixed income flat. There is no new interest in U.S. bonds as safe havens on the ETF level.

EXHIBIT #4 : GLOBAL ETF FLOWS

^{Source: Bloomberg, BNY}

Bottom line

Q2 will require a balancing act depending on whether the view that a Fed rate cut is necessary becomes normalized. Growth now dominates equity trading. The weaker U.S. data in Q1 and the notable decline in consumer and business confidence reflects future fears of tariffs. The implementation of tariffs on April 2 will be a key factor in determining whether the positions at home are aligned with those abroad. The risk of a larger rotation trade that includes fixed income again in U.S. portfolios needs to be monitored in the month ahead.

Weekly charts for equities