Key Highlights

• Cash cushions, seasonality and hopes of Fed cuts lift risk appetite; iFlow still points to a grind up, not a sharp rally
• Flows favor re-industrialization, AI, utilities and banks, but positions are stretched, Consumer Discretionary is the key sentiment barometer
• Summer liquidity and tariff uncertainty keep focus on economy and single-stock volatility

View chart pack

Looking for new leadership in U.S. shares requires faith in the consumer

EXHIBIT #1: IFLOW U.S. SECTOR FLOWS AND HOLDINGS FOR THE LAST 20 DAYS

_Source: BNY

(Technical note: The 10-year sector average for holdings is 1, while flows are z-scored against the last year.)

While April was the cruelest month for markets so far in 2025, July is expected to be the kindest. The consensus is that seasonality is pressuring investors to reload risk in H2 2025. This, along with healthy cash holdings, is driving expectations that equities will go higher. The macroeconomic case rests on the view that the FOMC is going to ease soon (if not in July, then in September) and that Trump’s tariffs are benign – and will result in negotiations rather than price shocks for consumers. The ongoing rolling deadlines on tariff implementation means tariff inflation and inventory rundown data will be more of an autumn risk than a summer risk. As a result, July trading is linked to positions and flows as they tread the same overtraded paths. Q2 earnings reporting season starts next week, and expectations are modest while the Q2 growth outlook is robust, suggesting further upside risks. Defensive buying of safe sectors to cover the risks of a recession or other geopolitical shocks is waning, and we are setting up for bullish outcomes. We are currently seeing a tug of war between hard and soft economic data, policy shifts between taxes and tariffs, and revenue models with a global vs. a national focus.

Our take 

Over the past month, traders have been searching for a new macroeconomic theme, but they’ve landing back on the same themes we saw in April:

• U.S. reindustrialization led by technology
• AI investments driving service sector productivity
• Utilities serving as both a safe haven and a play on data center growth
• Financials seeing ongoing wait-and-see Fed policy supporting deposits and easy Fed stress tests allowing for larger dividends and buy-backs

The fear of being too defensive showed up in the selling of Consumer Staples as fears of a recession receded, while Communications Services is seeing ongoing profit-taking from those who bought the dip in April. The view on vulnerable sectors remains unchanged albeit moderated by the overall market rally – led by Energy and Health Care, while Materials and Real Estate continue to see short covering pressure. The one sector that stands out over the last month is Consumer Discretionary, as it has been in every quadrant of trading – from seeing inflows and long positions, to outflows to the current short covering.

Forward look 

The other glaring risk for July equity markets is that every U.S. sector that is short is already seeing inflows. Further forced buying of shares in a “melt-up” scenario requires active short positioning. iFlow makes clear that we do not have the required setup for a significant rally, but rather a more gradual, grinding move up. Momentum factors in the typically low volume months of July and August usually fall apart with larger volatility on any negative surprises, which means that any Q2 earnings misses will matter more to individual names. Further, IT and Financials look overstretched and at risk in the month ahead. Changing positioning and flows serve as a good barometer of U.S. risk, with Consumer Discretionary leading the mood shift over the past month.

U.S. Q2 earnings outlooks are low, but positioning is neutral

EXHIBIT #2: CORPORATE EPS REVISIONS UP AND DOWN VS. PUT/CALL RATIOS 

_{Source: BNY, Bloomberg}

Our take 

Q2 EPS for the S&P 500 is around 5%, significantly lower than Q1. And revisions are larger than the five-year average of –3.2%, with current Q2 EPS cuts at –4.2%, down to $62.83 from $65.55. This suggests it should be easy to beat expectations. Also, the put-to-call ratio for the index reflects a very modest earnings skew. According to our holdings data, U.S. equity holdings are just 1% over their 10-year average. However, among companies changing their outlook, the number of companies warning on earnings is the lowest in a year, and the number with an improving outlook is the most since Q3 2024. Rising expectations for Q2 are part of the price in the S&P 500, which is trading at record highs.

Forward look 

In order to determine the market’s reaction to Q2 earnings, we need to make a value comparison with the rest of the world. In Q2, U.S. shares rallied following tariff relief on trade deals, passage of the “Big, Beautiful Bill” and resolution of the U.S. debt ceiling debate. Further, the surprise calm following U.S. action against Iran’s nuclear sites, along with stable oil prices left investors waiting for more news to justify holding defensive positions. The distribution of outcomes is evenly skewed into the rest of the month – something that has not been the case to date in 2025. The ability of U.S. markets to continue their melt-up depends on a comparison with the rest of the world, as we continue to see home bias and USD hedging as dominant themes. The risk of another sell-off comes from the EU and select APAC holdings.

The rest of the world is watching emerging markets vs. the U.S.

EXHIBIT #3: EM EQUITY SECTORS FLOWS AND HOLDINGS FOR LAST MONTH 

_Source: BNY

EXHIBIT #4: GLOBAL EQUITY SECTORS FLOWS AND HOLDINGS FOR LAST MONTH

_Source: BNY

Our take 

The vulnerability of the financial sector outside the U.S. stands out, as does the momentum buying of IT. Investors are not making money in Consumer Discretionary outside the U.S., while all positioning reveals the same dynamic as the U.S. – namely short covering in the last month, coupled with chasing momentum in the same sectors. iFlow data as we move into Q2 earnings season highlight the skew of positioning to the upside. The key will be the shift between active and passive management flows following a company’s report. Given current holdings and flows, misses will be punished more than normal, while beats may produce less upside unless it’s in an underheld sector.

Forward look 

The impact of tariffs and wages on U.S. markets will be compared against the role they play in the rest of the world. With tariffs delayed amid negotiations, companies are still waiting for clarity. AI can be used to counter labor costs, but this strategy is mainly being used by hyper-scalers, putting the investment focus on Financials and Industrials. Emerging markets play a special role in investment flows given their cheap labor markets. Tariffs are now more important to companies than wages when it comes to potential expenses. The Q2 earnings watch will focus on how many line items matter in Q3 outlooks. Industries that must lock in long-term labor deals – retail, autos, airlines and delivery services – are also likely to be watched as they are less agile and more vulnerable to price shocks. Immigration and the effect of a shrinking U.S. labor force with job skill mismatches are important factors for wages. While geography used to be a key supply chain factor for some companies – like footwear makers and computer manufacturers – tariffs are reducing that flexibility. Investments in new factories or payrolls may last longer than tariffs, but they are not an immediate solution. For many investors, this means emerging markets will serve as a new barometer for seeing how S&P 500 companies are able to manage prices aside from putting any increases on consumers.

Bottom line

The role the rest of the world plays in driving Q2 earnings will be tested by EPS numbers, with foreign revenue key for over 30% of returns. USD weakness will be one factor in the reports, but so too will be balancing labor costs and investments as uncertainty and volatility test the leadership in the index. Financials and Information Technology are priced to win. This positioning will be in a tug of war in the bottoms-up analysis ahead.

• Start of Q2 earnings season will bring into focus valuations vs. real yields, breadth vs. leadership, buy-back vs. funding markets for equities.
• Forward guidance matters more than beating 5% EPS consensus for growth, while cross-border investor reactions are expected to break the stalemate of retail vs. investor flows.
• Our investor flows suggest bar-belled approaches have a limit, with a key focus on Consumer Discretionary as a barometer of the current cycle. Holdings in EMEA and APAC are 5–10% overheld compared to the historical average.
• The corporate focus has shifted from wages to tariffs as the primary expense driver, with large firms outperforming small ones, but with limits from labor. Second order effects may show up in the investment cycle and deeper cost-cutting plans.

Q2 results will be stress-tested against higher tariffs and higher wage costs against weaker global demand and a weaker USD. Q3 outlooks seem likely to skew to the downside again.

Chart pack