State Street SPDR ETFs: Trump squeezes, ECB eases
State Street Investment Management has identified the key considerations for investors in the coming quarter. This section contains our market outlook for the coming quarter as well as the complete listings and recent standard performance for all factor-based Smart Beta SPDR® ETFs.
This quarter we expect a split in macroeconomic fundamentals, and the associated central bank responses, to drive a divergence in opportunities between the United States and Europe. The world economy is anticipating a synchronized slowing, with consensus estimates for global GDP growth settling into a weaker range of 2.3% to 2.9%.
This performance places the 2020s on a trajectory to become the weakest decade for global growth since the second world war. The strong stock market performance has been a result of leadership of a small range of assets and inflation. Moreover, the primary cause for recent weakness has not been a traditional cyclical downturn but a significant and persistent headwind of policy-induced uncertainty.
This uncertainty led us to caution investors in our Q2 market outlook to seek shelter from the fallout of President Trump’s tariff-fuelled trade war by considering defensive exposures to dividend and low volatility stocks. Both exposures significantly outperformed the market in Q1 and historically have provided strong relative performance in down markets but the market recovery, beginning in May caused these strategies to underperform in Q2.
The potential negative impact of US trade policy has been delayed but not totally eliminated. On 4th July, President Trump signed into law a reconciliation bill which is expected to add significantly to the US federal deficit. Tariffs and fiscal stimulus are likely to put pressure on US consumer prices, impacting the ability for the Federal reserve (Fed) to ease monetary policy with lower rates.
The US is in an interesting position of strong, albeit narrow, earnings growth from hyperscalers versus stagflationary fears from an overall decelerating economic growth. The inflation outlook has forced the Fed and the European Central Bank (ECB) into fundamentally different policy tracks.
US companies may face a headwind if borrowing costs remain elevated, which will pressure profit margins and equity valuations. European companies, in contrast, are beginning to benefit from the tailwind of lower interest rates, which may justify portfolio allocation at current valuations.
This puts the Fed in a difficult position of maintaining a restrictive monetary policy stance while equity market valuations trade at a significant premium to historical averages. In contrast, the Eurozone is showing signs of recovery. Inflation is moderating steadily toward the 2% target, which has allowed the ECB to embark on a monetary easing cycle.
Supportive monetary policy, combined with targeted fiscal stimulus in defence and infrastructure and more attractive equity valuations, create a compelling investment case for the Eurozone. This is especially true for domestically focused small caps, as well as value/dividend stocks trading at significant historical discounts.
A divergent landscape creates unique opportunities in developed equity markets:
Developed Market and U.S. Quality stocks: A focus on companies growing earnings with robust balance sheets as measured by a track record of strong, high margin, free cash flow. These firms are best positioned to weather economic uncertainty, protect margins, and navigate a high-cost-of-capital environment.
European Dividend stocks: A strategic allocation to stable, income-generating European companies. This approach aims to capture the benefits of Europe's cyclical recovery, supportive policy environment, and attractive relative valuations, while providing a defensive yield cushion.
The valuation disparity between the market-cap-weighted index and the equal-weighted index reveals a significant underlying risk. The combination of a cyclical economic recovery, a dovish central bank, and attractive valuations makes a compelling case for European equities.
In an environment of slowing growth and high interest rates, high-valuation US growth stocks are vulnerable to a market correction based on a change in earnings momentum or investor sentiment. This argues for a more nuanced factor-based approach in both Europe and the US.
