US market correction

Since the beginning of the year, financial markets have been marked by high volatility and a notable correction in US equities. While European markets have performed strongly, led by the banking and defence sectors, US equities have reacted negatively to uncertainty from a number of sources.
 

Why this correction in US markets? 

Several elements have contributed, including:

• Stretched valuations as a starting point: the S&P 500 Index has become historically expensive relative to 10Y US Treasury yields. For the first time since 2002, investors are accepting a zero risk premium to own stocks, meaning they rely solely on earnings growth to justify current valuations.
• Economic and political uncertainty: the US administration has made a number of contradictory announcements, particularly on tariffs, fuelling concerns among businesses and consumers. Economic sentiment is weakening, especially consumer confidence and PMI (Purchasing Managers' Index) surveys. The risks of reigniting persistent inflation are increasing.
• A challenge to AI-driven growth: the markets are reassessing the outlook for big tech companies, especially with regard to AI (artificial intelligence). The recent challenges to Nvidia's business model from the cheap Chinese chatbot DeepSeek, as well as the correction in tech sector valuations, have amplified the decline in US indices, especially those dominated by the Magnificent 7 tech giants.

What next for the markets?

US equity markets have recorded significant declines (c10% decline in USD terms for the S&P500 since its high of the year and c15% for the Nasdaq 100). Other indices and asset classes have also suffered from this fear of weakening US growth, in particular small caps and growth stocks that have underperformed the rest of the market. The US dollar has also been impacted, falling c5% in March.
 
In comparison, European equities have outperformed, benefiting from a repricing of their valuations and a return of investors to so called "value" sectors such as banks, and defensive sectors. The discount in valuation of European equities to US equities has narrowed from -42% to -33%, although it remains below its historical average of -22%. This has been helped by a downward convergence of expected earnings growth in the US in 2025 and 2026 with that of Europe. However, economic uncertainties in the eurozone remain an obstacle to a rapid appreciation of European equities, following their strong performance at the beginning of the year. A "race to the bottom" remains possible, in the event of a sharp slowdown in growth.

In the face of the uncertainties listed above, US bonds have held up better. The JPM GBI US Treasury Index (USD) is up 2.7% YTD, while gold has continued to play its role as a safe haven asset, advancing by 9% YTD. While the US Federal Reserve and the European Central Bank are expected to gradually ease their interest rate policies, the market might be overly optimistic about the pace of rate cuts, especially in the US. AXA IM expects one cut by the Fed by December 2025 against three cuts expected by the market. As for the ECB, AXA IM still expects four more cuts this year, to reach a key rate of 1.5% in December. This could help create a floor for equity valuations, albeit still at high levels, as well as helping with growth and debt management, especially for small caps.

AXA IM Select view

In the face of these uncertainties, we chose to neutralise our regional equity allocation in February, pending more clarity on the development of valuations, earnings revisions and the economic and political outlook. We remain neutral on equities overall, a position we have held since Trump's election. Although the idea of "American exceptionalism" is being questioned in the short term, it is still too early to say that there will be a definitive shift in market dynamics. Volatility could remain elevated, and investors will need to keep a close eye on economic and monetary policy developments.