Overview

Reversals and regional divergence were the key themes in the first quarter of the year as uncertainty rose in the lead-up to U.S. President Donald Trump’s initial global tariff announcements on April 2 —themes that continue in the subsequent month’s market tumult. Equity factors performed quite well over Q1, and macro factors exhibited strength despite extreme policy uncertainty and what felt like the beginning of an economic regime change for many countries around the globe (Exhibit 1).

Global equity markets were down over the quarter, in aggregate, though beneath the headlines the moves were very much regional stories. Following 4Q 2024—a period of euphoria and exuberance in U.S. equity markets and at the factor level, where speculative growth stocks led the way—the S&P 500 declined 4.27% in Q1, its worst quarterly performance since Q3 of 2022. DeepSeek’s announcement of lower cost artificial intelligence (AI) models led investors to question AI stock valuations, and tariff announcements and growing uncertainty around the impacts of Trump administration policies further weighed on U.S. stocks. A significant sector rotation also occurred within U.S. equity markets.

European equity markets rose sharply in Q1 as the Trump administration’s confrontational approach galvanized EU policymakers into action—on defense and/or infrastructure spending. Asia-Pacific stocks also rallied, producing the best quarter for international stocks relative to the U.S. in over 20 years.

Q1 also saw U.S. economic growth projections revised downward due to the expected impacts of government austerity, the threat of imminent tariffs and weakness in consumer confidence, which depressed U.S. Treasury yields even as the Federal Reserve (Fed) took no action on interest rates. But European growth prospects, supported by fiscal spending potential, pushed yields higher there. Rates also rose in other international markets, and against this backdrop, the U.S. dollar fell relative to its major trading partners’ currencies. Meanwhile, commodities (precious metals, in particular) rallied.

Equity factors are attractive in aggregate, led by the equity value factor. While we have a neutral view on other equity factors and macro factors, we emphasize that our neutral view implies positive returns.

We favor diversification in an uncertain environment and, as we look ahead and see clouds and uncertainty for traditional assets’ performance, we expect factors to gain support as potentially diversifying sources of return.

Factors in focus

Equity factors rebounded, led by international developed markets

Following their first decline in seven quarters in Q1, global equity factors were back in positive territory in Q2. International developed market factors’ performance was strongest, continuing a recent trend. U.S. factors also ended Q1 with positive returns after a tough 4Q 24 (Exhibit 2).¹

Developed market value stocks performed particularly well, benefiting from several European governments’ commitments to ramp up defense spending, and from Germany’s announcement of plans to increase fiscal spending on infrastructure. Value stocks also performed well in Japan, where reflation continues: The Bank of Japan raised its policy rate, defense spending increased and Berkshire Hathaway added to its holdings in Japanese trading houses.²

In a departure from the 4Q 24 theme in the equity and equity factor markets (exuberance about the incoming Trump administration), 1Q 25 was marked by a cautious tone in U.S. markets, which proved a better backdrop for U.S. equity factors. Still, performance was relatively muted on a sector-neutral basis, which is the way we define factors.³ Some of the biggest stories in the first quarter were sector-driven moves—such as the previously depressed energy sector’s 9% surge, which opened a more than 20% performance gap above the (until now) higher flying information technology and consumer discretionary sectors. Those were down about 13% and 14%, respectively, over the quarter.

Looking ahead, the value factor remains inexpensive across geographies, which should provide a tailwind for performance over the medium- to long-term. Within the U.S., the value factor is more than one standard deviation inexpensive, relative to its long-term history. While U.S. value is not as attractive as it was in 2020–2023 (following the dislocation of the post-COVID bubble), it is nearly so and has reached the level of attractiveness attained during the dot-com bubble of 1999–2000.

Within international developed and emerging markets, the value factor is not quite one standard deviation inexpensive relative to its long-term history, but is at levels more attractive than during most (two-thirds) of the 20-plus years we have measured the factor. That signals the potential for above-average returns in the international value factor.

Turning to quality, the factor remains attractive when measured among U.S. small cap and emerging market (EM) stocks; however, it has become expensive when measured across international developed stocks. For U.S. large- and mid-cap stocks, the quality factor’s valuations are in line with their historical average.

Neutral valuations for U.S. large- and mid-cap stocks—which now constitute a large proportion of global equity markets—might suggest that the quality factor should return to earning just its long-term expected return as a compensated factor, but no more. Interestingly, however, that is not necessarily the case.

We are seeing significant dispersion across some of the fundamental measures we use to define the quality factor, which may support a stronger outlook. Using return on equity (ROE), for example,⁴ we’ve seen the difference in ROE for high quality and low quality companies trend wider.

On a long-term basis, high quality companies earned a 20%–30% ROE, on average, vs. low quality companies’ 0%–10% average ROE, a 20 percentage point (ppt) to 30ppt gap. Today that gap is above 30ppt, which typically only happens during market dislocations. Given this wider dispersion, it would be fair to conclude that investors should be willing to pay more than usual for high quality U.S. large- to mid-cap stocks, relative to their lower quality peers. That, in turn, would support the case for the quality factor earning higher than usual rates of return as these valuations are further priced in (Exhibit 3).

Macro factors: Carry, currency and commodity factors lead the way 

Macro factors performed well despite the rising uncertainty and market reversals over the first quarter. Carry factors outperformed momentum factors but both were positive, supported by gains across asset classes.

The FX EM carry factor again gained, led by the outperformance of high carry currencies such as the Brazilian real, which enjoyed its best quarter in years as Brazil’s central bank hiked interest rates, and investors unwound their bets on dollar strength. The Colombian peso, another high carry currency, also fared well, rising alongside commodity markets. FXG10 factors also performed well, as favored currencies including the Norwegian krone and Japanese yen were lifted by high energy prices (for the former) and the expectation of interest rate hikes (for both). Currencies, such as the Australian and Canadian dollars, fell on weaker growth in those economies.

Within fixed income markets, the real yield factor benefited from being positioned long U.S. Treasuries as Treasury yields fell in Q1 amid concerns about U.S. economic weakness. The real yield factor also benefited from short positioning in Bunds (German rates rose on the change in fiscal spending expectations) and Japanese government bonds (JGBs, whose rates rose on prospects for reflation).

Commodity factors also enjoyed a strong first quarter. Investors in the commodity momentum factor benefited from long positioning in gold and silver, which rallied on tariff concerns, while commodity carry benefited from short positioning in certain agricultural commodities that fell over the quarter.

Rounding out macro factors, time-series momentum (also called trend) factors were also positive in Q1. Gains were led by long positioning across European equity and precious metal markets. Reversals in other markets—such as U.S. equities and certain government bond markets—happened slowly enough that trend signals could react in time.

Looking ahead, we continue to hold a neutral view of macro factors. FX carry spreads remain wide, relative to the past 18 years since the global financial crisis (GFC), with annualized spreads ticking down slightly, from 3.4% to 3.3% (vs. a 2.5% post-GFC average). Still, these spreads are neutral relative to longer-term history. Fixed income carry, similarly, is higher than during the post-GFC period, with real yield spreads at 2.1% (vs. a 1.6% post-GFC average) but neutral relative to longer-term history. Commodity carry spreads also remain neutral, albeit ended the first quarter slightly tighter, once again.

We also remain neutral across macro momentum factors. That is because FX market dispersion is low, commodity market dispersion is lower than it was a few quarters ago, and time-series or trend-following momentum signals are still mixed. Trend positioning is long European equities but flat for most other equity markets, and slightly short duration, in a reversal from last quarter when trend positioning was slightly long.

Concluding remarks

We continue to see generally attractive prospects for equity factors, with the value factor appearing inexpensive globally, and the quality factor supported by strong fundamentals among high quality U.S. companies. We generally rate macro factors as neutral, relative to long term-history; however, FX and fixed income carry have more attractive annualized carry spreads than during much of the post-GFC period.

With uncertainty rising and change in the air, we continue to see factors as attractive opportunities for diversifying sources of return.

¹ The U.S. value factor was down over 10% in 4Q 2024, its second-worst quarter in our records that date back to 1990, eclipsed only by the quarter the COVID-19 pandemic broke out. The U.S. quality factor was also down significantly in 4Q 2024, experiencing its sixth worst quarter in our records.

² The sōgō shōsha, sometimes translated as general trading companies, are uniquely Japanese large, diversified firms involved in a wide range of businesses.

³ Our equity factors are defined in a sector-neutral manner, which means, for example, we would look within the information Technology sector to identify which stocks are cheap vs. expensive, or high quality vs. low quality or have strong momentum vs. weak momentum, rather than playing a factor by favoring information technology stocks vs. those from another sector.

⁴ ROE is one of three profitability ratios, and 10 overall metrics, that we use to define the quality factor.

Glossary

• Equity value: Long/short global developed stocks based on book-to-price, earnings yield, dividend yield, cash flow yield; sector and region neutral
• Equity quality: Long/short global developed stocks based on financial risk, profitability and earnings quality; sector and region neutral
• Equity momentum: Long/short global developed stocks based on price change and earnings revisions; sector and region neutral
• Equity size: Long/short global developed stocks based on market capitalization; sector and region neutral
• Macro carry: FX G10 carry, FX emerging market carry, fixed income term premium, fixed income real yield, commodity carry
• Macro momentum: FX cross-sectional momentum, commodity cross-sectional momentum and time-series momentum across equity, fixed income and commodity markets

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