By Adam Kuerbitz, Alan Wynne and Vinny Amaru

Market Update 

U.S. equities are heading towards their second consecutive week of declines.

This week, Nvidia (-11%) exceeded earnings expectations but forecasted a decline in their gross margins, disappointing investors. Political news added to the selloff as President Donald Trump affirmed that 25% tariffs on Canada and Mexico will take effect on March 4, with an additional 10% tax to be imposed on Chinese imports.

The culmination of these factors is leading the S&P 500 to decline -2.5% this week, turning year-to-date performance negative. The largest companies in the index (Magnificent 7, -8.4%) and the largest sector (tech, -5.6%) have weighed on returns year-to-date.

Meanwhile, across the pond, Europe continues its outperformance. The Stoxx 50 is heading towards finishing the week up +1.1% as sentiment in the region has driven a valuation expansion.

Given the growth scares in the U.S., fixed income is once again providing diversification. Yields on the 10-year are heading towards their seventh consecutive week of lower yields – the longest streak since 2019. The 10-year yield (4.26%) is 17 basis points lower this week and the 2-year yield (4.05%) has declined 15 basis points.

As diversification has come back into focus, today’s note focuses on global equities and fixed income.

Spotlight

2025 began with Wall Street in consensus. Slowing growth in Europe and China, contrasted by a release of animal spirits and deregulation in the U.S., was expected to lead to a continuation of U.S. exceptionalism.   

Two months into the year, that consensus expectation hasn’t materialized. The U.S. is toward the bottom of the list in developed country equity performance, while Europe and China have rallied.

Chinese equities entered the year trading over two standard deviations below their average forward price-earnings ratio (P/E) over the last three years. A significant advancement in artificial intelligence (AI) technology through DeepSeek’s “Mode-of-Experts” method changed sentiment in the region. Equities rallied, and valuations increased, leading to the forward P/E now trading about one standard deviation above its three-year average.

A similar story unfolded in Europe. The region typically trades at a 25 to 30% P/E discount relative to the U.S. but entered the year at about a 40% discount. In mid-January, earnings expectations troughed and saw an increase of roughly 1%. Combined with a tailwind from increased defense spending as terms are negotiated to end the war in Ukraine, the region has rallied +12% year-to-date.

What’s common in both stories is that we don’t believe anything in the fundamental drivers of the economy, or the earnings picture has changed – the rally was driven by sentiment and a valuation catch-up.

Conversely, the underperformance in the U.S. was driven by a lag in the tech sector. Softer data in the U.S. and news that Microsoft may be canceling some of its data center leases caused a selloff in the S&P’s largest sector (tech at 30% of the index). Additionally, the largest names in the index have lagged behind their peers, with the Magnificent 7 declining -8.4% year-to-date, a change from the last two years when they contributed 60% and 54% of index performance in 2023 and 2024, respectively.

The outperformance ex-U.S. is why we advocate for diversification in portfolios: to capture those pockets of outperformance from other markets. We believe investors may want to consider an allocation to the developed world ex-U.S. equities in the MSCI World Index which can serve as a good benchmark for investor portfolios.

We advocate for diversification not only across equity geographies but also across asset classes. One such asset class, which was also an out-of-consensus call for 2025, is fixed income.

Investors have pushed back against fixed income because its correlation with equities has risen over the last two years, meaning that fixed income isn’t “zigging” when equities are “zagging” as it has in the past. However, that’s because the shock we experienced in markets over that period was an inflation shock. Fixed income doesn’t always cushion portfolios from inflation. As the name suggests, your income is “fixed,” and if prices are rising simultaneously, then all else equal, your purchasing power has eroded. This is why we have advocated for adding resilience to portfolios to hedge from inflation through assets like real estate, infrastructure, structures and gold.

However, fixed income does still help diversify portfolios; it hedges them specifically from growth shocks regardless of increasing correlations with equities. As such, we’re reminding investors of some of the fundamental principles of fixed income investing to guide their 2025 portfolio allocation decisions.

Bonds today are better positioned against a rate selloff. A concern often raised by investors who held bonds through the rate selloff of 2022 is the risk of adverse performance if rates increase again. The critical difference between a rate selloff now and the rate selloff that began in 2022 is that an investor today receives much more income because of the higher starting yield.

We can see an example of this if we compare the performance of the 10-year Treasury in early 2022 to late 2024. The 10-year Treasury yield increased by approximately 80 basis points over the first quarter of 2022 and the fourth quarter of 2024, but the starting yield at the start of Q1 2022 was only 1.5%, while the starting yield in Q4 2024 was 3.8%. Performance was 200 basis points higher in 2024 because the starting yield was more than double that during 2022. In other words, investors received more than twice the income they had received two years earlier to offset a similar shift in rates. Higher yields can provide a cushion to adverse moves (rising) in rates and compound on top of price appreciation in an advantageous scenario (falling rates).

Starting yield can be a very good indicator of future return. About 88% of the five-year annualized Bloomberg U.S. Aggregate Bond Index (Agg) return can be explained by the starting yield. Even without a regression analysis, this makes logical sense. Yield to maturity can be interpreted as the average rate of return that will be earned on a bond if it is bought now and held to maturity. As long as the issuer does not default, which is unlikely in investment-grade sectors, an investor can expect to receive approximately the starting yield in annualized total return for the duration of their investment regardless of how rates and spreads change or how the equity market performs.

Investors are once again compensated for interest rate risk. Fixed income markets passed a milestone on October 23, 2024, when the Bloomberg U.S. Agg Index once again began to outyield the 3-month Treasury bill. For the first time since January 2023, investors were compensated for stepping out of cash and taking credit and duration risk. For those clients with excess cash, now may be the right time to consider an allocation to fixed income assets, not only for the pickup in yield but also for the hedging power in a traditional growth slowdown. The risk to this approach is that resurgent inflation and subsequent rate volatility can lead to a selloff, but our base case remains anchored in continued disinflation even if the Federal Reserve pauses for an extended period.

Rotating from cash to a short-duration municipal bond or investment-grade corporate strategy both pays a yield premium over cash and offers hedging from slower growth. This wasn’t the case six months ago. Consider these dual advantages when allocating capital.

Curious as to how diversification can help you achieve your long-term goals? Reach out to your J.P. Morgan advisor.

All market and economic data as of 02/28/25 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

DISCLOSURES

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

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Index definitions:

Gold: The U.S. Dollar Index (USDX) indicates the general int'l value of the USD. The USDX does this by averaging the exchange rates between the USD and  major world currencies. 

Hang Seng: The Hang Seng Index is a free-float capitalization-weighted index of a selection of companies from the Stock Exchange of Hong Kong.

The STOXX® Europe 600 is a broad measure of the European equity market. With a fixed number of 600 components, the index provides extensive and diversified coverage across 17 countries and 11 industries within Europe’s developed economies, representing nearly 90% of the underlying investable market.

The Solactive United States 2000 Index intends to track the performance of the largest 1001 to 3000 companies from the United States stock market. Constituents are selected based on company market capitalization and weighted by free float market capitalization.

The Russell 3000 Index is a capitalization-weighted stock market index that seeks to be a benchmark of the entire U.S. stock market. It measures the performance of the largest 3,000 U.S. companies representing approximately 96% of the investable U.S. equity market.

The S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight of the index total at each quarterly rebalance.

The Bloomberg U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

The Magnificent Seven stocks are a group of influential companies in the U.S. stock market: Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla.

The Magnificent 7 Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, Tesla) classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System (BICS).

The S&P Midcap 400 Index is a capitalization-weighted index which measures the performance of the mid-range sector of the U.S. stock market.

The S&P 500 index is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases. 

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The Russell 2000 Index measures small company stock market performance. The index does not include fees or expenses.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

The views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. Information presented on these webpages is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.

RISK CONSIDERATIONS

• Past performance is not indicative of future results. You may not invest directly in an index.
• The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time.
• Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.
• In general, the bond market is volatile and bond prices rise when interest rates fall and vice versa. Longer term securities are more prone to price fluctuation than shorter term securities. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. Dependable income is subject to the credit risk of the issuer of the bond. If an issuer defaults no future income payments will be made.
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• As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
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