The dominance of the technology sector in US equity market returns was a key theme in 2024 with the rise of the ‘Magnificent 7’. The sector has been a major factor for markets from the arrival of the internet in the 1990s. The Covid pandemic accelerated the phenomenon further, with artificial intelligence giving it yet another push.
US import tariffs have now put the brakes on economic growth and corporate profits, but arguably less so for the technology sector. Unlike much of the rest of the market, the sector’s revenues come from primarily from services, so tariffs have less impact. This helps explain why the sector has outperformed since the early April ‘Liberation Day’ announcements.
While investors are well aware of this dynamic as far as US equities are concerned, they may not appreciate how much it has been a factor for emerging market (EM) equities, too.
The tech sector dominates returns even more there than in the US (see Exhibit 1). Investors wishing to capture this factor should note that market indices focused on growth and value styles are not a good proxy due to the way they are constructed. Nor does allocating to the MSCI Emerging Market Asia index do the trick.
For Europe and Japan, there is little difference in returns as the technology sector is comparatively small.
It’s all about earnings, also for tech
The fundamental reason for the outperformance of tech stocks is companies’ superior earnings growth. Given the impact of tariffs on goods producers, and the drag on energy sector earnings from now low oil prices, equity investors looking for growth need to seek out indices with a meaningful exposure to tech. Expectations for the level of earnings over the next year suggest the historical outperformance of tech-heavy indices could continue (see Exhibit 2).
As well as the earnings advantage, some markets have a valuation advantage, too. The z-score for the forward price-earnings ratio (P/E) for the tech-heavy NASDAQ index is just 0.4, somewhat above average, but still at the low end compared to other major indices (see Exhibit 3).
A z-score of 0.0 for EM technology means that forward P/E ratios are at their long-run average, and comparatively more attractive even than in the US. For value-oriented indices, the Russell Value stands out with a z-score of 1.4. This explains the high z-score for US equities overall. Given the similar earnings profile shown for European equities in Exhibit 2, their far lower z-score would appear to make them a more attractive proposition.
Geopolitics – A strong driver of market movements
Geopolitics have been dominating the headlines and driving market movements to a particularly high degree recently. Were the conflict in the Middle East to re-escalate, it could lead a sharp rise in oil prices, with negative consequences for inflation, economic growth, and risk assets.
At the time of writing, a fragile cease fire appears to be holding, but investors will be monitoring the news to determine whether the situation has truly stabilised.
Given the limited market reaction to the military exchanges between Israel and Iran – Brent oil prices rose by just $10 per barrel before falling back – there has been little economic impact.
Recent data, then, gives us a reasonable picture of the current state of global economy. Retail sales and purchasing managers’ indices (PMIs) paint a picture of modest growth in the US, but ongoing struggles in Europe.
US tariffs still a worry for European industry
Let’s start with the manufacturing PMIs. Worries over the impact of US import tariffs are concentrated in this sector. The three European countries that have reported so far – France, Germany, and the UK – have shown continued contraction. The rate of contraction has accelerated in France, but slowed in Germany and the UK (see Exhibit 4 lower half of table).
Exhibit 4
Purchasing managers’ indices show modest US growth and a struggling Europe
Data as at 29 June 2025. *Institute for Supply Management. Sources: FactSet, BNP Paribas Asset Management.
While US tariffs are thus a drag on European manufacturing activity, the region has actually had sub-50 PMI readings for months before they came into effect. This suggests its problems are more broad-based. Plans for increased infrastructure and defence spending should lead to a reacceleration in activity, but this is not likely to occur for many months.
In contrast to Europe, the US manufacturing PMI came in better than expected at 52.0. As intended, tariffs benefit US manufacturers insofar as they do not depend on imports for their inputs, as demand is redirected.
The Institute for Supply Management’s manufacturing activity indicator, however, posted a sub-50 reading in May. We will see whether it continues to send a contradictory signal.
US consumer demand slowest since Covid lockdowns
Services activity is similarly capped in France and Germany, though better in the UK, offsetting to some degree a poor May retail sales figure.
The impact of tariffs on services activity should be minor, which again suggests that slowing activity in Europe reflects broader problems. The data is particularly worrying when one considers that the ECB began lowering its policy rate in September last year.
In contrast, the US services sector continued to expand at a robust pace (53.1). This is not to suggest all US data has been positive. May’s retail sales showed a month-on-month gain of just 0.4%. While better than the 0.1% decline in April, the average so far for the second quarter is a meagre 0.1%, just one-third of the growth rate in the first quarter.
This is important because one of the key weaknesses in first-quarter US GDP data was consumer demand (personal consumption expenditures). The figure was revised downward again in the latest update to the slowest rate since the Covid lockdowns.
The weak retail sales data suggests PCE growth is unlikely to be stronger in the second quarter, particularly as price increases from the tariffs have yet to show up in prices in the shops. While many investors anticipated a slowdown in consumer demand this year as excess household savings ran out, it may be happening to a greater degree than expected.
Market reaction reflects US/Europe two-way street
The divergence in economic activity on either side of the Atlantic has been mirrored in equity market performance. So far in June, the MSCI Europe index has been flat in local currency terms, while the US S&P 500 has risen by 4%.
Ten-year US Treasury and Bund yields have remained near the low end of the range they have been in over the last several weeks, with worries over the bulging US budget deficit and President Donald Trump’s ‘Big Beautiful Bill’ having faded for now.
It is nonetheless challenging to predict how both US and eurozone yields may evolve from here. For the US, worries over fiscal sustainability could return as the Senate proposes its own version of the bill, leading to another rise in term premia and nominal yields.
Alternatively, a tariff-spawned slowdown in US growth could push the US Federal Reserve towards opting for further interest rate cuts.
In Europe, the recent commitment by NATO members to significantly raise defence spending may eventually lead to increased bond issuance. At the same time, a surge in imports from China may add to deflationary pressures in the region.
The US dollar has mostly stabilised since ‘Liberation Day’, but the DXY index — which measures the dollar’s exchange rate against a basket of six developed market currencies — is still 10% lower than at the beginning of the year.
One of the key factors in understanding this decline are portfolio flows: are foreign investors selling US assets or US investors buying foreign assets?
Recently data from the US Treasury tells us what occurred in April.
Typically, the US sees portfolio inflows, which are the mirror image of its current account deficit. April, however, was the fourth largest month of outflows since 1978 (see Exhibit 3). It could even have been as the second largest, insofar as the two months with the greatest outflows occurred during the Covid pandemic, which was a unique situation.
These outflows show that there was a change in the perception of investors on the advantages of investing in US assets relative to non-US assets after the tariff announcements.
Given that being overweight US equities was a consensus view after President Trump’s election, it is little surprise that the reaction to an event which challenged that was so strong.
The question now is
- To what degree will these outflows persist (‘sell America’)
- Will the dollar continue to depreciate?
Time will tell, but it is worth noting that since April, exchange-traded fund (ETF) flows show European investors returning to US assets.
If the dollar depreciates further, one of the beneficiaries could be emerging market equities. During the last period of sustained dollar deprecation, from 2002 to 2011, emerging market equities consistently outperformed those of developed markets.
By contrast, there was no correlation between the dollar and the performance of US equities compared to non-US equities (see Exhibit 6).
Asset allocation update
- As geopolitical risk adds to global uncertainty, we tactically cut equities to protect our portfolios’ returns after the strong rally since mid-April. Our positioning remains cautiously positive, equally split between developed and emerging markets
- Volatility related to the tensions in the Middle East and the deadline for tariff negotiations could provide buying opportunities
- The diverging outlooks for inflation and monetary policy supports our long position in European government bonds versus short positions on US T-notes. Duration remains globally neutral
- On gold, our long-term conviction remains positive. Gold should continue to benefit from the imbalance between supply and demand given the regular purchases by emerging market central banks. However, investors’ extreme optimism has led us tactically to take profits and return to a more neutral stance.
