Equities Broaden Out, at Last

This quarter has seen a further broadening in the equities story that has unfolded since the start of the year. Future bouts of market volatility are expected, but this story is unlikely to fade.

While bond investors have rightly been increasingly concerned by the fiscal profligacy of some of the world’s major economies, equity investors have instead been more focused on monetary easing and the potential for growth.

This partly explains why global equity markets have performed strongly in the quarter so far, extending a remarkable and broad-based rally since indices plummeted in early April.

In fact, international equity markets including China, Europe, emerging markets and Japan have handsomely outstripped the 10% returns of the S&P 500 Index in the year-to-date.

What’s more, U.S. large-cap stocks beyond the ‘Magnificent 7’ mega-cap technology stocks are gaining notable momentum, and small caps have rallied, with the Russell Microcaps Index delivering returns of over 45% since April 8.

In contrast, bond investors, more concerned about fiscal sustainability, have been pulling back from the long end of the government bond markets, forcing up the 30-year yields in the U.S., U.K., Japan and France to new highs—some even hit multi-decade levels last week.

Long-dated yields have since eased slightly, but they are expected to remain elevated thanks to high and rising fiscal deficits—increasing the prospect of higher issuance at higher borrowing costs—with bouts of volatility likely to continue. At the time of writing, another weak payroll report on Friday—reinforcing the case for the Federal Reserve to cut rates, consistent with our fixed income team’s long-standing view—drove Treasury yields lower, with the 10-year note falling back towards 4%.

Greater Breadth

The broadening in performance of equities, and volatility at the long-end of the government bond curve, are themes we have highlighted since the beginning of the year.

We expected the broadening in equities to develop because of the better earnings growth prospects coming into 2025, particularly for the U.S. economy, but also in other major economies including China, Europe and Japan. While trade and tariff policy uncertainty has clearly slowed growth to below trend, the economic resilience of the U.S. and other advanced economies has been impressive, reducing the probability of recession. Together with this, continued monetary easing and pro-growth fiscal policies, particularly in the U.S. and Europe, are supporting confidence in the growth outlook.

The result, in the quarter so far as well since the start of the year and early April, has been the broadening we anticipated.

In the quarter-to-date, for instance, the Russell 2000 Index of small-cap stocks is up 8.8% compared to 4% for the S&P 500. The Russell 2000 Index (6.4%) trails the S&P 500 (10%) in the year-to-date, but generally small caps have outperformed large caps since early April.

International equities are similarly having a strong quarter, extending their run since the start of the year when they have outperformed U.S. equities in dollar terms, led by China. The MSCI China Index has soared 32% since January, followed by the equivalent index for Europe (24%), emerging markets (20%) and Japan (17%). Excluding the U.S., developed market equities have outperformed U.S. equities overall by the highest percentage (12%) in over thirty years, driven, in part, by the decline in the U.S. dollar.

There are a mix of factors driving this regional divergence, including differences in economic growth potential, monetary and fiscal policy dynamics, and equity valuations.

Most importantly, we are also seeing a broadening in U.S. corporate earnings.

For example, year-over-year earnings growth for S&P 500 companies was up 12% in 2Q overall, and 8% when excluding the Mag-7 stocks, marking one of the higher growth rates in recent quarters.

Furthermore, the positive forward earnings growth of large caps across industries has been markedly improving in recent months. Over the next few quarters, we expect the companies that comprise the S&P 493 to close the earnings gap with the Mag-7.

In small caps, the earnings story is also promising, especially relative to large caps. Indeed, estimated year-over-year earnings growth for the Russell 2000 small caps—at about 30%—is forecasted to be higher than large caps in 2025, reversing a two-year earnings recession for the segment. At about 10%, the year-over-year earnings growth estimate for the S&P Small Caps 600 Index is lower and more in line with large caps, but it is still promising.

Spurring this revival is the prospect of further monetary easing by the Fed, together with the resiliency of the U.S. and global economy, especially as it relates to trade and capex cycles, to which small caps are closely connected.

More Broadening to Come

While growth is expected to remain modest over the near-term, some promising signs this may change are emerging. The U.S. economy grew at a revised annualized rate of 3.3% in the second quarter—revised up from the initial estimate of 3%—and data last week from The Institute for Supply Management suggested the services industry, the largest part of the economy, is gaining some traction after five straight months of sluggishness.

These signs do need to be seen in the context of a weakening labor market, as indicated by last week’s non-farm payrolls and the ADP and initial jobless claims numbers. In our view, however, this should embolden the Fed to cut rates later this month, potentially catalyzing growth and further accelerating this broadening theme for global equities.