After two years of strong performance, expectations for a repeat in 2025 were modest, yet U.S. equities have unexpectedly underperformed compared to developed market peers.

Concerns about a U.S. recession have reduced, leading to a rebound in U.S. equity performance in 2Q 2025, as the market prices out the worst-case scenario. “Sell America” is really just a sensationalist news headline. What investors could consider is to rebalance their allocation from a very overweight position in U.S. equities.

In the near term, the U.S. market could face further pullbacks. Corporate America is likely to experience margin pressure due to weaker economic demand, while higher tariffs and potentially prolonged elevated rates impact input and capital costs. Consensus earnings expectations have been slow to adjust to this outlook. Earnings growth expectations for 2025 remain relatively high at 9%, compared to the average U.S. earnings growth of 8% over the last decade, whereas low single digits may better reflect an economy narrowly avoiding recession.

Investors should balance near-term headwinds with long-term investment objectives. Over the last decade, the S&P 500 has risen by 164%, compared to a 41% increase in global ex-U.S. equities (MSCI World ex-US Index). This divergence was driven by faster earnings growth in the U.S. and expanding margins, justifying rising equity multiples. Additionally, deregulation and fiscal expansion are likely to support economic activity later in 2025 and into 2026, offering support to equity markets.

Investors must be mindful of valuations, which reflect a more optimistic economic outlook at the index level as the forward price-to-earnings (P/E) ratio has risen back to 21.2x. However, there is dispersion within the market. For instance, the valuation premium between the top 10 stocks and the rest of the U.S. market is narrower than at any time during 2024, despite stronger earnings from many mega-cap names in the first quarter of 2025.

This narrowing may reflect that parts of the tech sector could be vulnerable to tariff risk due to exposure to global supply chains, prompting investors to differentiate between hardware and software within the tech sector. Meanwhile, sectors such as financials and utilities may be less sensitive to tariff impacts due to their greater domestic orientation and potential benefits from deregulation.

Overall, sector and style biases should give way to a focus on quality, and companies with strong balance sheets should be capable of weathering the U.S. economic slowdown and maintaining pricing power to preserve margins.

The long-term investment thesis for U.S. equities appears favorable, given their higher return on equity and faster long-run earnings growth potential linked to secular themes in technology. Return expectations for U.S. equities in 2025 may align with non-U.S. global markets, suggesting a rebalancing of U.S. equity exposure rather than an underweight position.

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