Mark Luschini, Chief Investment Strategist

In February’s issue of Investment Perspectives, we postulated that the “exceptionalism” of the S&P 500 indexes’ performance versus the rest of the world, particularly Europe, was due for an extended breather. In other words, our thinking was that the advance in European equity prices already underway would be sustainable in both absolute terms as well as, and importantly, relative to the U.S. equity market. Indeed, so far this year, European equities, as measured by the Euro Stoxx 50, an index comprised of blue-chip companies across 11 Eurozone countries, are handily outperforming the S&P 500.

Certainly, this can be partially explained by the economic news emanating from Europe, which is less grim than many expected. Inflation has been grinding lower, and the European Central Bank has rapidly reduced interest rates to a much less restrictive level. In addition, European households hold an abundance of excess savings accrued during the pandemic that has helped fuel consumption as rising consumer confidence boosted spending.

However, the real catalyst that has charged European equity prices and unlocked the unusual valuation disparity between the U.S. and European stock markets is the recent announcements by the German government and the European Commission regarding major spending initiatives.

First, new German Chancellor Friedrich Merz introduced a sweeping fiscal overhaul, including a $500+ billion infrastructure package, as well as a commitment to spend more than $400 billion on building out Germany’s military complex. This was a huge surprise as it flies in the face of Germany’s historic, notoriously tight limits on government borrowing. Separately, European Commissioner President Ursula von der Leyen proposed extending more than $800 billion in loans for its sovereign members to boost defense expenditures (targeted to raise it to 3% - 4% of each country’s GDP) and loosen the fiscal rules constraining individual countries’ national spending limits. Furthermore, France’s President Emmanuel Macron welcomed the moves as advancing Europe’s unity and ensuring its defense and security. Collectively, these efforts are occurring in a fashion neatly tied to former European Central Bank President Mario Draghi’s highly publicized research report promoting policy determination and further coordination of Europe’s economic strategy.

In our view, investors have good reason to view this shift in the fiscal impulse as a bullish setup for European stocks. While spending announcements will only have a modest impact on annual economic activity since they are expected to drip out over the next decade, it does raise optimism that Europe is shaking off its fiscal shackles and pursuing a more integrated course of action. However, the swift and perhaps somewhat impetuous move in share prices has run too far, too fast. Global trade uncertainty has surged, and the Trump Administration’s tariff policies and potential retaliatory responses could enact a drag on cross-border activity. Europe is more sensitive to trade than the U.S. because exports account for 52% of GDP in the Eurozone compared to 11% in the U.S. Any diminution of growth across Europe caused by a trade war would dull the profit picture for European companies and impart an adverse reaction on share prices.

Additionally, defense company stocks have run well ahead of themselves in anticipation of massive military outlays within the European equity market, amplifying the broader indexes’ returns. These stocks are overbought and vulnerable to a sizeable bout of profit-taking, especially considering that the budgeted defense procurements will be spread over time and will not have an immediate impact on the sector’s profits.

That presents a risk that a near-term pullback could be in the offing. All else equal, we believe that would create an opportunity for investors who may have missed this rally to climb aboard. For those with current positions in the Old World, a correction in prices should not derail the structural thesis supporting the favorable longer-term developments emerging across the continent.

Foreign Developed Bond Markets

Guy LeBas, Chief Fixed Income Strategist

There’s a tendency among U.S.-based investors to think of fixed income in terms of what the Federal Reserve (Fed) is doing and what’s happening in the Treasury market. But if you zoom out just a little, the view gets more complicated—and more interesting. Government bonds from developed foreign markets—the biggest being Germany, the UK, and Japan—make up a large share of the $70 trillion in non-USD bonds globally. Thanks to a mix of regulation, investor behavior, and the realities of currency markets, those bonds are more relevant to U.S. investors today than at any point in recent history.

In part, that’s because many global financial institutions now operate under harmonized regulatory frameworks. Basel III, which governs banks, and Solvency II, which governs insurers, treat most G10 government bonds similarly from a capital requirement standpoint. A Japanese insurer doesn’t need to hold Japanese bonds specifically—any high-quality G10 bond will do. If UK gilts or Canadian bonds offer a better yield or liquidity profile, our hypothetical insurer can easily allocate overseas. That regulatory fungibility has quietly collapsed some of the traditional walls between domestic and international bond markets.

Put differently, the notion that U.S. Treasuries are somehow in a separate asset class from JGBs (Japanese Government Bonds) or Bunds (German bonds) does not hold up anymore. One recent example comes from Germany’s plan to issue Bunds to expand defense spending. On March 5, 10-year Bund yields increased +0.30%, the biggest one-day move in contemporary history. In sympathy, 10-year Treasury yields rose +0.09% despite some negative economic news in the U.S. that would have otherwise caused U.S. yields to fall.

Although there is clearly some connection between global and USD interest rates, from a portfolio construction perspective, how correlated are foreign interest rates with U.S. interest rates? So far in 2025, correlations have been declining, which augurs for including an allocation to foreign-developed bonds in well-balanced fixed-income portfolios.

Most foreign-developed market bonds are denominated in local currencies, meaning USD-based investors face FX risk unless they hedge. But that also introduces opportunities. If the dollar is weakening, owning Euro- or Yen-denominated bonds might deliver excess returns even if yields are modest. Conversely, a strong dollar can erode those gains. Understanding the policy paths of the ECB, BoE, and BoJ isn’t just a macro curiosity—it directly affects total return.

Chart 1: Correlations Between US & Foreign Yields Have Been Falling in 2025

The next few quarters could see some surprising moves from foreign central banks. The ECB is nearing the end of an easing cycle. The BoE is facing volatile inflation in the short term but is similarly drifting towards easing. Meanwhile, after years of ultra-loose policy, Japan is slowly testing the waters on higher rates. Just as importantly, the fiscal situation in most of these countries is arguably more stable than that of the U.S., which reduces the chance of economic or issuance surprises.

Market pricing is about expectations, not absolutes. If the Fed holds cuts in mid-to-late 2025, and the ECB remains on hold, the Euro could strengthen, making eurozone bonds more attractive on a hedged or unhedged basis. If the BoJ surprises markets with even modest rate hikes, the yen could rally, and JGBs—despite low absolute yields—could outperform in dollar terms.

It’s All in the “E”

Gregory M. Drahuschak, Market Strategist

Last month, our hope was for a positive break from the trend of mediocre earnings expectations. That did not happen. Technical factors suggested that potential market weakness could be well contained, but those factors were not enough to avoid a mid-month break that, by March 28, saw the S&P 500 spike down to its lowest level this year. However, extremely negative market breadth and negative sentiment spawned a temporary snapback rally that was not enough to avoid ending March and the first quarter with losses of 5.75% and 4.59%, respectively. March 2025 saw the S&P 500 post its fourth worst loss of the month in the last 76 years.

In the long run, stock prices are a function of earnings and, most specifically, their growth rate. Recently, the growth rate of expected 2025 earnings has slipped.

At its peak so far, 2025 S&P 500 earnings were expected to be 12.8% above the final for 2024. As March drew to a close, the growth rate had slipped to 9.0% as the estimate for 2025 S&P 500 earnings was lower in 23 of the preceding 29 weeks.

Chart 2: 2025 S&P 500 Earnings Estimate

Earnings up 9.0% year-over-year still would be an excellent result, especially considering the strong upward thrust in earnings for the prior two years, but concern developed that the equity market’s rise that sent the S&P 500 to all-time highs in February might have accounted for it already.

On top of this, even with the drawdown in the S&P 500 since the February 19, 2025, peak, the market’s valuation remained relatively high at a 21.1 price-earnings ratio. This set up first quarter earnings season results as key, not only for April stock price results, but also possibly deeper into 2025.

Table 1: Expected 2025 Earnings Result

The obvious incongruity between expected earnings and year-to-date sector results, to a degree, reflects increasing skepticism that previous market leadership will retain that position, and instead, more defensive areas of the economy are favored.

All of this leads us to think that the coming earnings season will have a consequential role in determining how the market might fare in the coming months.

Table 2: Ten Best and Worst S&P 500 April Results

Financial firms will have a lot to do with early earnings season sentiment. Friday, April 11, 2025, earnings reports are due from BNY Mellon (BK), JPMorgan Chase (JPM), Morgan Stanley (MS), Wells Fargo (WFC), BlackRock (BLK), and State Street (STT), followed the next two business days by reports from Goldman Sachs (GS), M&T Bank (MTB), Bank of America (BAC), Citigroup (C), and PNC Financial (PNC). By April 17, 2025, these reports, along with others from different sections of the economy, will provide a good view of the path of earnings and the stock market.

Typically, April ends what normally is the best six months of the year for stocks. From 1950 through 2024, the S&P 500 ended the month of April with a gain in 52 of the possible 75 months for an average gain for all Aprils being 1.42%, which on average is the third-best month of the year. In the previous 20 years, the S&P ended April down only four times.

There is a theory that investors investing their tax refunds might help to boost stock prices in April; however, we believe a more likely explanation could be that portfolio rebalancing at the end of March leaves many institutional investors with cash that is immediately redeployed as the new quarter begins. However, in our view, these are somewhat flimsy reasons to explain April’s typical strength.

The market outcome for April is likely to hinge on tariff news and how it might impact the trajectory of expected S&P 500 2025 earnings. Achieving April’s typically positive result this year might be a challenging task.