Trending
Written by: Jack White | Todd Asset Management
Markets have changed since the beginning of the year to favor international and value-oriented styles. Many investors are now overweight growth-oriented styles after a long run of outperformance, so we think it is an appropriate time to consider increasing your portfolio diversifiers, including international and value stocks.
Earnings remain strong and the economy continues to expand, but uncertainty about the U.S. outlook has increased and concerns about a growth scare have been cropping up. At the end of last year, “U.S. exceptionalism” was the hot topic, but we hear less of that now. The new administration’s policy unpredictability has hurt consumer confidence, and tariff concerns have weighed on U.S. investor sentiment. Early this year, most economists did not believe the Trump administration was serious about tariffs or trying to curb government spending, however, recent announcements from the president, the Treasury Secretary and DOGE (Department of Government Efficiency) have proven otherwise. The administration is committing itself to these efforts and appears willing to tolerate the economic adjustments these efforts could cause to bring the U.S. economy back into balance. We think efforts to curb the federal deficit are likely to cause more concerns about U.S. growth as the year goes on. At the same time, international economic outlooks are likely to firm somewhat as Europe and Japan need to prepare to defend themselves, and more stimulus is occurring as China seeks to re-invigorate their consumers.
Rotation has been the biggest indicator of the changing market we are noting. In 2023 and 2024, U.S. large cap growth stocks — more specifically the Magnificent 7 — dominated the markets and U.S. equities outperformed international by a wide margin. Since the beginning of the new year, however, investors have rotated out of U.S. growth into international, value-oriented stocks as the S&P 500 and Russell 1000 Growth Indexes are now negative year-to-date (through 3/7/25) versus the MSCI ACWI ex-US which has gained roughly 8% and the Russell 1000 Value Index up over 2%.
What is driving the rotation?
- The Magnificent 7 have seen profit-taking as a new, lower cost Chinese artificial intelligence (AI) company introduced an open-source large language model that users are adopting. Additionally, recent quarterly results reported by U.S. companies raised questions regarding the potential return on investment (ROI) for the investments that they have been making. The Magnificent 7 have become more capital intensive, which might be giving investors concerns too.
- International indices have benefited from strength in European stocks. The Euro Stoxx 50 just reached a new high after 25 years, and many individual markets in Europe are making new highs. We believe that Europe, the UK, and Japan have broken out and are in secular bull markets.
- Recent U.S. actions on the war in Ukraine have forced Europe to abandon austerity and commit to stimulus for infrastructure and defense. Many European economies pursued austerity after Covid and are now becoming stimulative. Another major shift is that the U.S. is pursuing austerity after years of expanding stimulus. This is a fundamental reversal that could last for some time.
- Hong Kong, where the large Chinese technology companies trade, has been a strong market this year despite tariff talk. The surprise launch of the AI chatbot mentioned above is a strong reminder that Chinese companies can bring competitive products to the market. Other Chinese companies are following suit and challenging U.S. dominance of the AI market. Additionally, China has committed to continued fiscal stimulus to promote consumption to meet their growth targets.
The mantra of the United States’ new administration seems to be the same one used in Silicon Valley: move quickly and break things. Investors like predictability and the disruptive nature of this administration has investors on edge. Early indications are the administration’s tactics are working. This could allow for better performance in the U.S. after an adjustment period. For now, stresses are beginning to grow, as we can see from credit spreads widening and market indications that U.S. investors are defensive, while international investors are more geared for economic growth.
Another concern is that one of the U.S. administration’s goals is a weaker U.S. dollar. Not enough space to go into detail here but read up on the Mar-a-Lago Accord if you are curious about how the administration would achieve this goal. Typically, international markets and value stocks do better than the U.S. when the dollar is weakening. Long-term, we remain secular bulls on the U.S. equity market, however, over the shorter term — particularly if tariffs exceed investors' expectations — we expect to see uncertainty and volatility. Historically, in uncertain periods, companies with high valuations are often the ones penalized.
We think that the market rotation is likely to last, and investors should be looking to add to their diversifiers, specifically value strategies and international investments. We currently favor several themes including financials, which can benefit from positive real interest rates, as well as energy and materials companies, which can benefit from stimulative policies and de-regulation. We also like companies supported by the new capital cycle including the build-out of new infrastructure, reshoring, and supply chain rebuilding. We also favor the companies within the AI universe that are reasonably priced. Lastly, we also like defense companies. Regardless of whether peace occurs or not, we believe there will probably be a greater investment in military/defense from European and Asian democracies and restocking in the U.S.
Related: Riding the Tariff Tornado: Why Market Corrections Are More Opportunity Than Crisis