For six turbulent months, equity investors faced a daunting combination of technological disruption, policy uncertainty and geopolitical tension. Reviewing lessons from the first half can help prepare for volatility that’s likely to recur in the quarters ahead.
Global stocks touched record highs at the end of the second quarter, after a very bumpy ride (Display). Stocks plunged in early April after President Trump escalated the trade war, muddying the earnings and growth outlooks. Later that month, equities rebounded sharply when a 90-day pause was announced on most tariffs.
US policy changes on issues including immigration, higher education and scientific funding prompted a global debate on the future of US exceptionalism. Fruitless efforts to end the Russia-Ukraine war were followed by a major Middle East conflict, as the Israel-Iran war in June spurred a temporary spike in oil prices. The US bombed Iranian nuclear sites on June 22, a historic event with potentially dramatic geopolitical consequences that added to market uncertainty.
Regional Returns Reflect Shifting Sentiment
Despite a chaotic environment, the MSCI ACWI Index rose by 11.5% in US-dollar terms in the second quarter, taking its first-half gains to 10.0%. European and emerging markets outperformed US stocks in the first half, even though the S&P 500 recovered some ground in the second quarter, driven by better-than-feared fundamental performance from the Magnificent Seven. The outperformance of non-US stocks over US stocks was driven further by a weakening US dollar, which fell by more than 9% and 13% against the yen and the euro, respectively.
Sector and style returns shifted during the first half (Display). Technology stocks recovered in the second quarter but remained slightly behind the MSCI ACWI index for the year-to-date after a weak start. Industrials did well, while energy and healthcare underperformed. Growth stocks surged in the second quarter, outperforming value and minimum volatility stocks, in a sharp reversal of first-quarter patterns.
Market turmoil this year has reinforced important lessons for investors on topics including behavioral reactions to downturns, diversification and coping with unpredictable policy changes.
Resist the Temptation to Sell at Market Extremes
Many investors know that selling in a falling market can be counterproductive. It locks in losses and often leads to missing out on gains during a recovery, because timing market inflection points is almost impossible. Yet, it’s hard to keep your mettle when markets are driven by fear and uncertainty.
Extreme volatility in the second quarter put even the most resilient investors to the test. Trump’s sweeping tariff announcements on April 2 sent markets tumbling 12% over the next week. But after the tariff delay was announced on April 9, global stocks surged by nearly 25% through quarter end.
History suggests that stocks have performed well after volatility peaks, in both developed and emerging markets. Our research shows that when the VIX Index of US equity market volatility reached unusually high levels between 40 and 50, returns for the MSCI World and S&P 500 averaged 37.4% and 34.4%, respectively, over the next 12 months. We believe that peak VIX levels—as seen in early April—reflect a fear of worst-case scenarios that often don’t materialize. When markets adjust to less extreme outcomes, equities typically recover. That’s why it’s important to stay disciplined in adverse conditions.
Keep Your Eye on Earnings
For us, discipline means staying focused on fundamentals. While we can’t control market gyrations and valuations, as active equity portfolio managers we can focus on our anchor of value: earnings.
Changing tariff policies affect earnings in complex ways and the first-quarter earnings season provided insight into how companies were adjusting. Some acknowledged supply chain challenges and were already accruing losses attributable to higher tariffs or lowering earnings guidance (Display). However, many companies are actively offsetting the pressure by diversifying or regionalizing supply chains, concentrating suppliers for volume discounts, increasing domestic sourcing and raising prices. More recently, as tariff headlines and geopolitical fears have moderated, earnings guidance and policy uncertainty have trended in more favorable directions.
Other companies face limited impact from tariffs, such as software and services businesses. Domestically oriented firms such as financials or utilities have also been relatively immune, as have companies with existing contracts or supply chains providing more visibility through changing trade conditions.
While tariff-driven volatility has receded recently, the trade war is far from over. As it evolves, our task is to find businesses better positioned to withstand tariff pressures. These will differ depending on a portfolio’s philosophy and stock-selection process. But across the board, we do know that playing headline roulette is a poor strategy for long-term investors. Instead, deep fundamental research must be applied to discover companies that can protect their profitability—and identify those most at risk.
Expand Horizons Beyond the US
Companies with staying power can be found everywhere. While US stocks have outperformed non-US stocks in recent years, we believe their earnings advantage isn’t set in stone.
Valuations in Europe, Asia and emerging markets are much lower than in the US. The extraordinary performance of US stocks since 2011 has been led by mega-caps, which has created significant concentration and imbalances in global markets that are ripe for reversal. However, even after we strip out the Magnificent Seven and technology companies, we find that the valuation of the MSCI EAFE Index continues to trade at its lowest multiples in over two decades (Display). Outside the US, we see many opportunities to find highly profitable companies. Catalysts for a resurgence of non-US stocks could include increased fiscal spending in Europe and Japan, concern about the vulnerability of US companies to tariffs, a weakening dollar and eroding confidence in the US as a safe haven. These trends could spur fund flows toward markets outside the US.
Return patterns this year provide a glimpse of what that might look like. However, a shift in regional return patterns isn’t likely to unfold in a straight line, as we saw during the first half. And consensus 2025 earnings growth expectations for the MSCI Europe and Japan’s TOPIX were 2.5% and 4.1% respectively in late June, much lower than 9.0% for the S&P 500, according to J.P. Morgan. That’s why we think investors should search for quality businesses with overlooked earnings growth potential at attractive prices, which could lead a long-term recovery of non-US stocks. As the world deglobalizes, it’s a good time for investors to consider diversifying regional exposures.
Be Selective in the US Mega-Caps
US stocks still deserve a prominent place in allocations, and the US market will continue to offer exceptional opportunities for selective equity investors. However, changing circumstances may dampen the market’s historic dominance.
The Magnificent Seven companies deserve scrutiny after a complex first half. In the first quarter, returns among the mega-caps diverged as the market became more discriminating about their earnings when DeepSeek of China highlighted disruptive AI threats (Display). Then, in the second quarter, the entire cohort advanced and the S&P 500 Equal Weight—a proxy for the broader market—weakened versus the cap-weighted index. Looking ahead, we think being selective within this cohort will be an important ingredient for generating better risk-adjusted returns.
Broadening of market returns away from the mega-caps won’t happen in a straight line. The mega-caps include great businesses, but passively owning the entire group is risky and holdings should be set according to a portfolio’s philosophy at appropriate risk-adjusted weights. History shows that after periods of market concentration and outperformance of passive portfolios, active managers performed better when markets broadened. For example, in the early 2000s, after a period where the biggest winners were the early access providers of the internet, markets broadened as leadership rotated to companies that benefited from the new technology. We believe similar patterns are being set up today.
Defensive Strategies Help Keep the Faith
Market concentration, trade wars and volatility can make it hard for investors to stick to a long-term investing plan. Defensive equity allocations can help investors with lower risk appetites stay the course.
With a coherent defensive diversification strategy, investors can gain exposure to companies that are relatively immune to tariffs, and technology businesses that capture AI innovation with lower risk than the expensive mega-caps. A portfolio that actively seeks to understand the risks from changing market dynamics in a disciplined way can help reduce losses in a downturn and capture the most gains in a market recovery. This type of strategy would have also helped investors cope with the April volatility. Curbing losses on the way down helps counter the behavioral instinct to sell at the wrong time, and bolsters confidence to stay invested for an eventual recovery.
What’s the common thread that ties our observations together? It’s a very simple idea for complicated times: keep your vision squarely focused on long-term outcomes—as an investor, analyst or portfolio manager. Reacting impulsively to chaotic news and capricious market moves won’t help solve strategic investing challenges in a world of higher inflation and lower expected returns. Whether it’s your personal investing goals or an earnings outlook, the best antidote to short-termism is to have a coherent forward-looking outlook that stretches three to five years ahead and serves as a trusted compass to steer you through the information fog.
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The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.
MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.
The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.
References to specific securities discussed are for illustrative purposes only and should not to be considered recommendations by AllianceBernstein L.P. It should not be assumed that investments in the securities mentioned have necessarily been or will necessarily be profitable.
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