The financial markets appear to be able to exert a pressure on US President Donald Trump that world leaders and historic agreements cannot. Despite his claim that he is “not even looking at the market”, the president postponed tariffs on Canada and Mexico as Wall Street plunged. However, the capricious approach of the new administration is likely to remain, and markets could be fragile as a result.
There has been a notable shift in performance since the start of the year, with the S&P 500 down 1.9% for the year-to-date and the Nasdaq down 5.8%. The CNBC Mag 7 index is down 10.3%, with only Meta outperforming the S&P 500 over the period. This is in notable contrast to other markets, including the Eurostoxx 50, which is up 11.7% and the FTSE All Share, which is up 4.9%.
Investors have started to talk about a ‘Dotcom bust 2.0’, with the current problems coming a neat 25 years after the original dotcom bust in March 2000. Investors have already voiced their concern about the level of concentration in the market, both in the technology sector and in the US markets more generally.
It is tempting to put this all at the door of a quixotic White House, but there are other dynamics at work.
Liz Ann Sonders, chief investment strategist at Charles Schwab said: “Several dynamics have contributed to this shift in performance dominance of the magnificent seven, and we think their struggle year-to-date is justified, or perhaps explained by the shifting earnings environment. At play over the past year has been a convergence in growth rates between the magnificent seven and the ‘rest of the market’. Earnings growth for the magnificent seven in 2025 is expected to come in lower than in 2024; the opposite is the case for the S&P 500 ex-Mag 7.”
This was confirmed recently by LSEG Datastream. It pointed out that magnificent seven earnings are expected to rise 17.1% in 2025, down from 36.8% in 2024, while S&P 500 ex. magnificent seven earnings are expected to rise 9.2% this year, an improvement from 6.9% last year.
See also: Has the UK been left behind by the growth wave?
It added: “Another way to look at it is through the lens of earnings growth contribution – magnificent seven contributed 52% of total net earnings growth in 2024, which is expected to fall to 33% in 2025.”
Aggregate earnings for the magnificent seven from their recent reporting season were strong, up 31.7% year-over-year. While this is significantly higher than the S&P 500’s 16.9% growth, it is the lowest growth rate for the group since the first quarter 2023. Partly, LSEG Datastream said, this is just the law of large numbers: “It becomes increasingly difficult for the magnificent seven to sustain the high earnings growth rates seen in prior years.”
It is the same outside the US. Citi has pointed out that part of the outperformance of the European markets has come from superior earnings. European earnings revisions look “more impressive than in the US” while “upwards revisions have been meaningfully stronger than seasonal patterns would predict”.
Where could money go?
The US markets are priced for US exceptionalism. If the US is no longer exceptional, it cannot expect to command the same premium. If the tide is turning for the US market, where might that capital go? Almost everywhere else has been neglected. The US markets have absorbed a huge amount of global capital in recent years.
In its latest report, Alliance Witan pointed out: “At the end of 2024, the index on average allocated around 150 times as much capital to each of Apple, Nvidia and Microsoft as it did to the average stock, akin to us placing about 95% of the portfolio in one manager’s hands and 0.5% each in the other 10”.
Nevertheless, that doesn’t necessarily mean that everywhere else is a bargain. Recent analysis from David Blitz, chief researcher at Robeco’s Quant Equity Research team, divided recent equity returns into earnings growth and multiple expansion: “This analysis highlights key differences behind underperformance. Small-cap and low volatility stocks delivered strong earnings growth but lagged due to stagnant valuations.
“Emerging market equities, however, struggled due to weak earnings growth, despite rising valuations. Taiwan and India were exceptions, posting solid earnings growth, though not enough to offset poor performance from China, Korea, and EMEA.
“Ultimately, small-cap and low-volatility stocks suffer from a lack of investor appreciation, while emerging market equities need a turnaround in operating performance… the healthy fundamentals of small-cap and low volatility stocks indicate potential future opportunities.”
So far, Europe has been the main choice for capital coming out of US markets. It may get a peace dividend if there is some resolution to the war in Ukraine. There is also a large fiscal stimulus package from Germany, agreed by incoming Chancellor Friedrich Merz.
There is hope that defence spending across the Continent will drive growth – and defence stocks have been strong recent performers.
Sonders said: “Significantly heightened policy-related uncertainty has contributed to this shift away from some of the market’s prior darlings and toward more defensive areas, and this rapid shift in performance is a reminder to be mindful of diversification and periodic rebalancing. Sector swings have been swift, and we expect that to persist throughout the year.”
Luca Paolini, chief strategist at Pictet Asset Management, said: “Europe is set to outperform over-pessimistic expectations. We can see an ongoing recovery in consumer spending in Europe, as confidence has recovered from the lows of the Russian gas crisis. Consumer confidence is still below average levels and the current rise in natural gas prices is unhelpful.”
See also: Diversification: The cornerstone of resilient multi-asset portfolios
Another beneficiary may be China. It announced a fresh stimulus package this week, and recent economic data has showed a marked improvement in performance.
Nicholas Yeo, head of China equities at aberdeen, believes Chinese companies are better prepared for the impact of tariffs this time, having diversified their production bases back during the first trade-war:
Yeo said: “This should make the impact of tariffs on corporate earnings more manageable…We remain cautiously optimistic about China’s outlook. With market expectations leaning towards low teens earnings growth in 2025, we anticipate that any upward revisions could be higher, contingent on the follow-through of both monetary and fiscal stimulus.”
This may provide an important refresh for global stockmarkets and finally see capital redirected around the world. The only problem may come if the downturn in the US proves more severe than expected. In that case, all risk assets may be in trouble.
