Key Highlights

• Fed rate cut and earnings fueling current global equity rally
• China valuations attractive amid trade détentet
• U.S. equity rotation risk increasing

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Is China a better value proposition for Q4?

EXHIBIT #1: IFLOW HOLDINGS OF CHINESE FX, FIXED INCOME AND EQUITIES

_Source: BNY

The melt-up in risk continued this week, with both Q3 earnings and the prospect of a Fed rate cut supporting buying – but with limits on both. A December cut by the Fed is not a sure thing and rapid spending on AI continues to worry bubble watchers. Growth and inflation in Q3 look to be non-issues, although this cannot be confirmed given the lack of official data (like GDP or PCE prices) amid the ongoing government shutdown. Much like investors, the Fed has a blank economic dashboard. The biggest headlines are the hardest to put into market models, such as the U.S.–China trade détente following the meeting between Trump and Xi in South Korea. Investors are rethinking the opportunities presented by Chinese and U.S. equities as we reach the halfway mark of earnings season with an eye to value, growth and momentum.

Our take

Chinese and U.S. equity markets have been more similar than different in 2025. Both were underheld in Q1, saw significant volatility in Q2 and experienced a rapid and notable rally in Q3. FX hedging is also an important factor in China, as cross-border investors clearly started to hedge their positions again in July. Global investors continue to be attracted to Chinese AI and industrial technology. Stable fixed income markets have also helped bolster the equity market, but Chinese bond holdings are average, while holdings of Chinese shares are 20% above their 1-year average but just 10% above the 10-year average.

Forward look 

The 12-month forward P/E is 13.2 for the Shanghai Composite and 14.8 for the CSI 300. Early Q3 earnings reports suggest double-digit growth for financials with ongoing improvement expected in Q4. Investors in Chinese equities anticipate a recovery of earnings, with preliminary reports showing this is the case. There is a steep discount between China and the U.S., with a strong focus on the AI supply chain and hardware as well as industrial technology companies. Macro headwinds from property and companies with a greater domestic focus are showing up in ongoing sector dispersion.

Overall, price breakouts since July have been a key momentum factor. The China value proposition should be supported by the trade détente as a result of Trump and Xi’s meeting. The critical factor driving momentum will be global growth, the internationalization of the renminbi via trade finance and rising dim sum issuance.

Will Q3 earnings drive another rally in risk for U.S. shares?  

EXHIBIT #2: IFLOW HOLDINGS OF U.S. FX, FIXED INCOME AND EQUITIES

_Source: BNY

Our take 

Investor holdings of U.S. bonds and equities are lower now than they were during the summer. In particular, equities are below average, mainly because cross-border investors shed positions in October. As the Fed’s rate cuts have removed some of the carry and risk premium, bonds have not served as a counterweight. While investors previously focused on USD hedging, the selling we saw in April stalled in the third quarter and is not a factor at present.

Looking at individual sectors, the 15% overweight in holdings of both IT and communications in the U.S. show there is significant risk of a rotation trade following Q3 earnings reporting. The driving force behind the decline in U.S. holdings is the 12-month forward P/E of 22.7, well above the 5- and 10-year averages. There is lingering concern about concentration risk involving high tech and AI shares, even with the Magnificent Seven beating expectations. The tech sector’s EPS is up 22% y/y, while semiconductors and equipment are up 48% y/y. Capex and AI are driving the U.S. story in Q3.

Forward look 

The U.S. market risk is skewed toward a melt-up, according to our holdings. The bull case for equities starts with Fed easing. Historically, the S&P 500 climbs when stocks are already high and the Fed cuts interest rates (with an average return in such scenarios of 20%). Earnings are clearly the other driver, as expectations that margins would be compressed as a result of inflation have so far not been borne out in Q3 earnings reporting. The broadening of U.S. earnings suggests a stable economy.

The other sectors beating expectations in Q3 will be important for the outlook in Q4. Financials have a blended EPS of 20%, Utilities are seeing gains on AI demand and Energy has had surprisingly positive results. The only negative so far in Q3 has been Health Care, with an EPS of –4% y/y.

Trade deals and tax reforms that go into effect in 2026 are adding to the case for higher shares, despite concerns about a concentration risk. Counterbalancing the bullish case are concerns that margins depend on job cuts, that the secular drivers of AI investment will be unresponsive to interest-rate changes and that inflation continues to shroud the broader economy in uncertainty.

Investor sentiment turns defensive despite market gains 

EXHIBIT #3: DEFENSE BEATS CYCLICAL GROWTH FACTORS IN U.S. EQUITY FLOWS

_{Source: BNY, Bloomberg, MSCI}

Our take 

Confidence in a U.S. soft landing has eased back to neutral – not as weak as in March, yet October’s flows skewed heavily toward defensive positioning even as U.S. equities hit new highs. The gap between our flows and broader market prices is striking, and we see the same pattern unfolding in other regions. Investors shed cyclical shares in favor of safer assets in October, and although the summer rally continues, institutional participation has remained muted.

Forward look 

Like the Fed, investors will be watching the data closely. Q3 earnings have kept stocks range-bound, but future rotation trades will demand fresher signals. Unfortunately, the U.S. government shutdown has delayed and undermined confidence in economic releases, amplifying volatility. If markets need to wait until mid-December for slowdown confirmation, they may lean on momentum and value factors instead – pushing equity risk higher rather than lower.

Bottom line

Global equities enter Q4 driven by different forces but exposed to the same risks. In the U.S., broad-based earnings strength and expectations of Fed easing underpin markets, but lofty valuations and a heavy tech concentration heighten the odds of a shift into cyclicals or defensive sectors amid lingering macro uncertainty. China, by contrast, offers cheaper valuations and early signs of broader earnings improvement – in financials, AI hardware and industrial technology – while policy support and easing trade tensions could fuel a re-rating. Still, growth headwinds, a fragile property sector and geopolitical risks temper the upside. For global investors, China’s valuation appeal and earnings-recovery momentum make it the relative-value play, whereas U.S. allocations should lean into selective quality growth and a diversified defensive allocation to navigate a late-cycle backdrop. Ultimately, liquidity conditions, geopolitical stability and forthcoming economic data – confirming that both economies can grow without reigniting inflation – will set the market’s course.

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