The outlook for US equities after a difficult first quarter

US equities have had a challenging start to 2025. Having peaked in mid-February, the S&P 500 approached correction territory less than three weeks later following a 10% fall.

To understand these moves, first we must consider the role of expectations. At the start of the year, many investors were bullish on the outlook for US stocks, assuming that the new Republican administration would succeed in its goal of Making America Great Again. This shift towards an “America First” policy stance was also expected to be very damaging for the prospects of other regions around the world. Instead, recent economic data is highlighting that the US approach to trade policy is hurting domestic sentiment, while also stimulating a forceful policy response from other countries, particularly in Europe.

Not all of the decline in US stocks can be attributed to the economic outlook, however. At the same time as tariff-related uncertainty has risen, the technology breakthroughs made by DeepSeek in China have raised questions as to whether the moats created by AI giants in the US market really are as wide as previously assumed.

Against this backdrop, the megacap tech stocks have been most vulnerable to profit-taking. After two consecutive years driving more than half of the returns of the S&P 500 index, the Magnificent Seven group of US companies are down 13% year-to-date, with valuations falling from a multiple of 32x forward earnings at the start of January, to 26x by late March. Other companies in the S&P 500 have generally outperformed the megacaps so far this year, with the so-called S&P 493 (the S&P 500 excluding the magnificent seven) broadly flat since the start of 2025.

A more granular look at the performance of the Magnificent Seven highlights that dispersion even just within this group has been elevated. Tesla’s performance is most eye-catching, with the stock down over 40% year-to-date, having now given up all of the gains following November’s US election. The rest of the Magnificent Seven have fared relatively better, but on average are still down by 10% since the start of the year.

Elsewhere in the S&P 500, the rotation witnessed at a sector level has had a clear defensive bias. Health care and utilities stocks have outperformed, while the strong cash profile of the oil majors, coupled with expectations for deregulation from the Trump administration, have supported the energy sector. At the other end of the spectrum, consumer discretionary (of which Amazon and Tesla make up roughly 50%) and technology are the two biggest underperforming sectors.

After two years in which the megacaps’ returns outstripped almost all other contenders, diversification at both a sector and style level is now working once again. From a regional perspective, given the 30% weight of technology stocks in US benchmarks, the rotation away from tech is also a key factor behind the US’s relative underperformance vs. other regions.

What next for US equity investors?

With recent volatility stemming from both macro concerns and tech-specific risks, the path of the S&P 500 over the rest of the year depends on incoming news in both areas.

Uncertainty around trade and other aspects of the US administration's policy agenda is leading to a ‘wait and see’ attitude from both businesses and households, which is curbing investment and making consumers a little more cautious.

With both household and corporate balance sheets looking relatively healthy, this behaviour should be consistent with a slowing in US activity rather than a recession. But recession risk will rise if policy uncertainty starts to damage the labour market, either because government cutbacks start to have a more substantial impact on broader activity, or because companies start to cut jobs to protect their margins from the impact of rising import prices. Whether this vicious cycle kicks in will depend in part on whether government policy becomes more predictable and business-friendly.

We continue to expect that the recent weakening in both the stock market and economic activity will ultimately lead the US administration towards a more moderate agenda. And with the midterm elections just 19 months away, we might expect pressure to reverse course to appear sooner rather than later.

Expecting economic realities to eventually thwart political ambitions is often correct, but not always – Brexit being a case in point. It is unclear whether Donald Trump and his team believe short-term pain is a price worth paying for what they believe to be the longer-term gain of a more closed economy with a thriving industrial base. So far, comments from the administration have implied a willingness to ignore market signals and a 'tolerance for short-term pain', which raises the risk of other policies that have been discussed being enacted, such as changing the payment terms for foreign holders of US debt and attempting to influence decisions by the Federal Reserve.

Even if the foreign agenda continues to be more hostile, the US market may be supported if the administration’s attention turns towards cutting domestic taxes. The fiscal bill currently making its way through Congress will see many alterations and it is possible that tax cuts start to become a more dominant feature of the market narrative.

With regards to the technology sector, in most part, balance sheets remain in strong shape and valuations based on forward earnings now sit in a more sensible place. It is worth bearing in mind, however, that these valuations still reflect expectations for very robust 20%+ earnings growth from the US tech sector in 2025. Any company guidance that indicates these expectations may be too high could cause more volatility.

Overall, we see two-way risks to the S&P 500 from here, and at this stage caution against panic. It is very common for significant intra-year declines to be completely reversed before the end of the year, resulting in strong full-year returns.

That being said, there are things investors should consider – for example, carefully managing technology exposure to ensure that holdings have truly strong fundamentals, and being ready to use periods of volatility to add to good companies at much more attractive valuations. It may also be worth making use of the benefits of geographical diversification, given that challenging news from the US is being met with additional stimulus in other regions, as Germany's recent fiscal package demonstrates. And finally, investors should be particularly careful of passive exposures (see our recent On the Minds of Investors piece), given both the S&P 500 and MSCI World are extremely exposed to the risks of tech and US underperformance.