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Is this the death of US exceptionalism? If so, what comes next? My sainted mother didn’t raise any kids dumb enough to call the trajectory of this market, but it’s clear that such questions are preoccupying investors around the globe, with markets swinging hither and yon with the news cycle.
The US equity rally, which had begun to narrow towards the end of last year—and was heavily reliant on the Magnificent 7 mega caps throughout—went into reverse in Q1 2025. The S&P 500 had been edging down from its mid-February peak before plummeting in early April. Markets arguably overreacted, as they are wont to do, and investors then pondered if the tariff war was a phoney one, and whether it would “all be over by Christmas”. At the time of writing, in the second week of May, the S&P has climbed back to more or less where it was at the start of April. As to where it will be by the time you read this, I can only refer you back to my opening paragraph…
This has, however, led to a rotation in equity market leadership from last year. Over Q1 2025, Europe, UK, emerging markets, Asia Pacific, and Japanese equity markets outperformed the FTSE All-World, while both US large- and small-caps lagged, particularly those with a growth bias. It would therefore be surprising if this hadn’t impacted on investor behaviour. So colour me surprised: despite the turmoil, US large caps continue to lead the charge in terms of asset flows.
Globally, Equity US was the second most popular fund classification in 2024, after Money Market USD, netting £252.89bn. Over the first four months of 2025, Equity US has taken most assets, even in April, in the very teeth of the storm. Only in March do we see a wobble, as it fell to fourth place, with Equity Europe topping the list (£11.58bn).
The same can’t be said for US small and mid-cap funds, however, which have borne the brunt of the disquiet over US equities, suffering redemptions of £54.44bn over the first four months of the year, exceeded only by redemptions from Bond CNY and Money Market CNY funds (chart 1).
Equity US Small & Mid Cap funds have been in the firing line, having fallen by 16.19% over the first four months of the year in GBP terms, compared to a fall of 10.36% for Equity US funds. In comparison, Equity Europe ex UK funds were up 5.94%, and Equity UK returned 1.82%.
Chart 1: Top and Bottom Global Fund Flows, 1 January 2025-30 April 2025 (£bn)
Source: LSEG Lipper
That’s the global view. Drill down, and the perspective shifts. European fund buyers have begun to react. With the US exceptionalism story under severe strain, they have cast a covetous eye to the Continent’s equities, and this has been reflected in these funds heading up the rankings, with Equity Europe being the most popular classification in Europe over March, and the fourth most popular over the quarter.
That’s quite a turnaround when you consider that, on a pan-European basis, Equity Europe funds suffered the second-worst outflows of 2024. The worst? That would be Equity UK, mainly because of continued selling by UK investors.
Chart 2: UK Fund Sales by Asset Class, Q1 2025 (£bn)
Source: LSEG Lipper
When it comes to UK investor behaviour, both equities overall (-£7.27bn) and bonds (-£2.51bn) sold off over Q1 (chart 2). The main beneficiaries were money market funds (£8.28bn). And, despite UK equities outperforming both their global and US peers, UK investors have continued to dump them, with Equity UK suffering Q1 outflows of £4.93bn; Equity UK Small & Mid Cap -£1.96bn; and Equity UK Income -£1.35bn. Meanwhile, UK investors still put £4.55bn into Equity US and £2.86bn into US-heavy Equity Global funds over the period.
What, you have to wonder, does an equity market have to do to get attention round here?
There are structural issues at play: UK pension funds have been divesting themselves of UK equities over the century. While they arguably don’t have that many more UK equities to sell, it’s likely that the shift from UK to global benchmarks by wealth managers is a contributing and ongoing headwind.
So, to return to the title: where do we go from here? In valuation terms, European and especially UK equities are cheap relative to their US peers, and the UK is cheap relative to its own history. That’s no new thing, however, and there’s a palpable weariness exuded by intermediaries when fund managers wheel this canard out in presentations. Just because something is cheap, doesn’t mean it won’t get cheaper still.
It’s possible that a sustained period of US underperformance could help catalyse a return to favour for UK equities. Cash coming into the market could spur corporate takeovers, as buyers take advantage of these tempting valuations. The sustained period of share buybacks, which we’ve seen for some time, could also amplify any upswing in prices.
Chart 2 would suggest that there is a lot of cash on the sidelines. Given current uncertainties, this is understandable. “Safe” bond assets can become fraught with risk, as we experienced in 2022 as rising rates caused falling valuations. Will tariffs prove inflationary, forcing a reversal in the rate trajectory? As Treasury markets rocked in April, it’s not surprising that many investors are sitting this out, waiting for a clearer market signal. Timing the “right” entry point, however, is notoriously difficult.
Returning to equities: perhaps the US will ride out these shocks. But it does seem that those same shocks have shone a light on investors’ increasing reliance on a narrow range of S&P 500 mega caps. UK investors have been more reluctant than their Continental peers to siphon capital to European alternatives, and few anywhere have thought the bargain-bucket valuations of our domestic market worth a rifle through. But, surely, it’s on the radar?
This article first appeared in the summer edition of Personal Finance Professional.
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The views expressed are the views of the author and not necessarily those of LSEG Lipper. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. LSEG Lipper cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.