Key Highlights

• Any Fed rate cut down the line could support U.S. equities
• Q1 earnings and the Q2 outlook have important implications for the risks ahead
• Where are the best opportunities for the rest of 2025?

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U.S. equity styles show cyclical upswing holding despite uncertainty

EXHIBIT #1: FLOWS INTO U.S. CYCLICALS RELATIVE TO FLOWS INTO DEFENSIVE EQUITIES VS. MANUFACTURING ISM

_{Source: BNY, Institute for Supply Management}

Where can value be found in the S&P 500? Our flows show that investors aren’t chasing recession risks but recovering from the fear of such risks. The role of Q1 earnings is important in this process. In the S&P 500, eight of the 11 sectors are reporting year-over-year growth, led by the Health Care, Communication Services, Information Technology and Utilities sectors. On the other hand, three sectors are reporting a year-over-year decline in earnings, led by the Energy sector. Sectorial performance and flows aren’t perfectly aligned, but cyclicals are leading in their surprises. Covering shorts plays a bigger role than simply establishing long holdings.

Our Take 

The trailing 12-month P/E ratio of the S&P 500 is 25.1, while the forward 12-month P/E ratio is 20.2 – both are above the long-term averages. The other value indicator that investors watch is the Buffet indicator, which is the value of all U.S. publicly traded companies divided by the country’s nominal GDP. This ratio is at 208%, which is about 1.7 standard deviations over the average of the last 75 years. The role of the USD in valuation comparisons is becoming important to global investors, and the 10% drop in the USD over the year to date allows for some offset against the extremes.

Forward Look 

With the U.S. earnings season more than 70% over, the Q1 surprise is that 76% of S&P 500 companies have beaten expected earnings, which is near the 5- and 10-year averages. According to FactSet, the average EPS is nearly 13%, which is well up from 10% last week and 7% at the start of the quarter. The average Q1 revenue growth rate for the S&P 500 is 4.8%, up from 4.5% last week and 4.4% at the start of the quarter. While revenue is close to the long-term average, they are below the beats of the last five and 10 years, making it clear that top-line revenue missed in Q1, but bottom-line earnings still beat. The discipline of U.S. companies is an important factor for understanding the Q2 risks ahead.  Uncertainty over tariff rates and policy will drive caution, which means less investment, less hiring and more nimble leadership actions as demand becomes clear.

• For Q2 2025, analysts are projecting earnings growth of 5.7% and revenue growth of 4.0%.
• For Q3 2025, analysts are projecting earnings growth of 7.8% and revenue growth of 4.7%.
• For Q4 2025, analysts are projecting earnings growth of 7.1% and revenue growth of 5.3%.

Are we returning to 2012 levels of equity holdings?

EXHIBIT #2: SHARE OF EQUITY HOLDINGS ACROSS REGIONS OVER THE LAST 15 YEARS

_Source: BNY

There are around 56,000 listed companies around the world. Regionally, the Americas accounts for 20% of global listed companies, APAC for 55% and EMEA for the remaining 25%. Global market capitalization is $120tn, with the U.S. accounting for $55.5tn, down from $61tn in November, but still the leader with 46% of the global market. The other notable regional leaders include China ($13tn) and Japan ($7tn), with EM APAC accounting for 12% of global market capitalization and DM APAC 7%. Meanwhile, Europe has $14tn in global market capitalization, or 13%, with the U.K. accounting for $3trn, or 3%. Holdings are a different story than the universe of listings or current market capitalization. The U.S. is by far the most dominant in terms of positioning.

Our Take 

Over the last 15 years, U.S. equities in our client portfolios have accounted for an average 65% of holdings but are currently at 71%. The comparable figures for Europe and developed APACT are 17% and 6%, respectively. To understand the current demand for equities, start with the sharp rise in wealth over the last 30 years coupled with a rise in the distribution of this wealth. In the 1980s, there were 4 billion people with 1.5 billion considered middle class or wealthier. Today, with a total global population of nearly 8 billion people there are 4 billion people in the middle class. Total global private wealth is estimated at $455tn, which is about four times annual global GDP. Global savings and global wealth are two different things. Savings rates vary by country, with the U.S. and U.K. in the single digits, while China and India are over the world average of 25% per year.

Forward Look 

The most important takeaway about savings and wealth involves the search for growth and safety, the two major themes that grew out of the volatility that we saw in April. We saw notable shifts in holdings for the U.S. and Europe in the period and it’s a move worth watching given the longer-term peak of November 2024 and the current decline in U.S. holdings showing up in our client asset allocation in equities by region. Greater capital account liberalization in emerging APAC will support developed equity markets but the U.S. needs to make its case through margins and earnings growth to justify staying exceptional with these new flows, especially as China continues to challenge high-margin and growth sectors, which exemplified U.S. equity exceptionalism.

Cross-border investors see weaker dollar to compensate for higher equity risk premias

EXHIBIT #3: CROSS-BORDER U.S. EQUITY HOLDINGS VS. CROSS-BORDER USD FLOWS

_Source: BNY

Our data indicate that cross-border investor behavior in the recent risk recovery shows a higher risk premia is being extracted in exchange for U.S. exceptionalism and over-allocations. The clearest manifestation of this is the rise in the hedging of U.S. assets (Exhibit #3). The immediate trigger was a shift in Fed expectations. Despite the FOMC’s gradual approach, the broader direction is now clear simply due to growth downgrades. Even considering the dovish shift in external policy paths, such as that of the ECB, the opportunity cost of not adding to USD hedges through rate differentials has increased. This has been compounded by the dollar’s advanced positioning relative to peers in Q1 and contributed to the outsized move.

Our Take 

Technical adjustments through hedging and positioning, however, cannot mask the risk of de-rating in U.S. allocations through dollar weakness. Assuming the U.S. is successful in turning around its balance of payments through a comprehensive set of new trading arrangements, the dollar will need to set a lower equilibrium level. A shift by U.S. companies toward external earnings will increase the sensitivity of domestic financial conditions to the dollar’s value, and a future Fed will need to manage such risks proactively, like the ECB and BoJ. Furthermore, domestic demand will need to decline, likely through a combination of private-sector restraint and public-sector austerity, which will likely depress trend growth and long-term U.S. rates. These changes portend de-rating risk for U.S. equities but will be favorable for the US Treasury market to maintain high levels of overseas allocations.

Forward Look

This week’s announcement of the U.K.-U.S. trade deal and impending talks between the U.S. and China suggest that the worst is over regarding goods-based tariffs. However, the U.S. has also opened a new front on services with a 100% tariff on non-U.S.-made films. If trade tensions spread to the services sector, where the U.S. enjoys significant global surpluses, the de-rating risk to U.S. equities would be significant. Disruptions to trade in financial services would certainly have a far larger impact on the dollar’s general status in the global financial system. Other sectors which underpin U.S. exceptionalism, such as communication, technological and legal services, may also show greater global demand elasticity than is currently priced in equity markets. 

Bottom line

Like all factors which impact financial conditions, the Fed’s rate cut matters for equities but for long-term investors, structural factors matter. Liquidity, safety and secular earnings potential drive risk premia. All of these factors are being re-assessed, and global holdings of U.S. equities could struggle in the near term. In a departure from more recent trends, cross-border investors clearly no longer wish to face multiple U.S. asset exposures. As the largest and most liquid asset, reducing dollar holdings is becoming the most cost-efficient form of portfolio insurance.

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