Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

The optimism that infused Asian and European markets on Monday evaporated as the global session progressed, with U.S. investors taking a 'glass half empty' view on the current global uncertainty surrounding tariffs and outlook for economic growth.

Wall Street's underperformance ended up being pretty marginal, but there's little doubt that a re-rating of U.S. assets is underway. More on that below, but first, a round up of today's moves on world markets.

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The selling frenzy that rocked world markets three weeks ago may have stopped but the relief rally that followed now appears to be fading, leaving investors nervously awaiting the next signal.

Absent an obvious catalyst like a surprise US-China deal on trade, markets will likely lack direction this week but remain choppy. Several events, including month-end rebalancing, U.S. 'Big Tech' earnings, a Bank of Japan policy meeting and U.S. Q1 GDP and April payrolls, should see to that. 

Benchmark equity indexes in Brazil, India and Japan have fully recovered their post-'Liberation Day' losses, Germany's DAX on Monday briefly revisited its April 2 close, while the MSCI All Country world index and Asia ex-Japan index are both within a whisker of regaining their April 2 closing levels too. 

U.S. President Donald Trump cooling his more belligerent rhetoric on tariffs and Federal Reserve Chair Jerome Powell have certainly helped calm the horses, and financial conditions around the world are beginning to loosen again. 

The dollar's continued decline has been a big part of that loosening, and the greenback retreated again on Monday. Many banks have slashed their long-term dollar forecasts, and there's a case to make that a weaker dollar would be a tailwind for markets and growth around the world in the years ahead.

But does that still apply if the dollar is slumping for 'negative' reasons like a global loss of faith in U.S. policy? What's more, stronger domestic exchange rates will harm non-U.S. companies' earnings and eat into their profit margins. Throw that on top of the tariffs that have still to come into effect, and it's easy to see why the recent sense of relief across markets is fading. 

Companies in Europe, where the euro has surged around 10%, and Japan, where corporate sensitivity to the exchange rate is always high, may be particularly exposed. 

UBS strategists argue that a diversified global portfolio should still include "substantial exposure to the world's largest economy and most developed financial markets," and in the more immediate term, they see scope for a 'tactical' recovery in U.S. risk assets, as has often been the case following periods of high volatility and investor pessimism.

But many will argue this can't last - trade and economic uncertainty is too high, visibility is non-existent, and the damage done to markets and investor and business confidence runs much deeper than seems apparent right now. 

The panic selling of U.S. stocks and bonds following the Trump administration's 'Liberation Day' tariff bombshell may be over, but the re-rating of American assets is just getting started.

The question is just how big this reallocation will be. Money managers are aware that even a modest reduction in exposure could have a potentially huge impact on asset prices.

That's both because of the sheer size of U.S. markets relative to total global assets, and the outsized nature of overseas investors' U.S. holdings in nominal terms and as a share of their portfolios. In Treasuries, this overweight exposure is large; in equities it is massive.

To illustrate the big impact that even small changes in allocations could have, it's worth recalling some of the numbers involved here.

For instance, the global pension fund industry, which is significantly overweight U.S. assets, is worth around $58.5 trillion.

Foreign private sector investors have flooded U.S. markets in recent years, pouring a net $3.25 trillion into U.S. assets over the last three full calendar years, according to U.S. Treasury data. Consequently, America's net international investment position is currently negative $26 trillion.

U.S. stocks accounted for as much as 75% of the $80 trillion global market cap earlier this year. And at the end of last year, foreign investors owned 18% of U.S. stocks, a record-high share going back to 1945, according to strategists at Goldman Sachs.

Additionally, Japanese and euro zone investors' U.S. fixed income allocations comprise around 60% of their foreign fixed income holdings and about 15% of their total fixed income portfolios, according to strategists at Exante Data. European investors' U.S. allocation has roughly doubled over the last decade, they note.