Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Markets. I'm your host, Tim Graf, head of macro strategy for Europe.

Each week, we talk about the latest insights from our award-winning research, as well as the current thinking from our strategists, traders, business leaders, clients and other experts from financial markets. If you listen to us and like what you're hearing, please subscribe, leave us a good review, get in touch, it all helps us to improve what we offer.

With that, here's what's on our minds this week.

TG: Earlier this year, the skepticism that started to circulate about US equities made a lot of sense. The secular bull market in stocks was 12 years old, valuations were stretched, positions were crowded, and crucially, the expectations for continued US outperformance this year were sky-high. And I must admit, I shared the skepticism, and to a degree, I still do, because none of the assertions I just made about US stocks have actually changed, especially now that we're almost back to all-time highs again after the correction and market volatility in April.

One of the luxuries we have as strategists, though, is we get to get out and talk to our clients as much as we can, and it really does help fine-tune our thinking. I was in the Middle East a couple of weeks ago, and it was an eye-opener of a trip in terms of hearing about the capital that can still flood into the US tech sector, despite all of those potential headwinds. And Marija Veitmane, she's our global head of Equity Strategy. She's actually in between stops on what's turning into a month-long road trip seeing clients.

And she's hearing many of the same positive things about investment in the tech sector. She stopped by the podcast this week, and we compared notes from our travels.

TG: Hello, Stranger.

Marija Veitmane (MV): Yeah, I feel like a stranger. Oh, it's been a while.

TG: It's been a couple of weeks, hasn't it?

MV: Yeah, and then another two of travel.

TG: I know, it's insane.

MV: How was your trip? Middle East, happy?

TG: Middle East was great. Each time you go, something is new, and something's different, and something's easier.

MV: Yeah, that's fantastic. Europe needs that.

TG: I mean, we were there the week Trump was there. So, everything was about artificial intelligence (AI).

MV: Yeah, yeah, yeah. More is to come.

TG: Yeah, like, that's actually a really great segue to talk about what we're going to talk about, because I didn't come away from there necessarily thinking differently, but there is definitely a counterargument to any skepticism one could have about tech and AI right now, which is that a very cash-rich part of the world is A, willing to throw a lot of cash in it, and B, much more willing to cozy up to the US and US companies who are-

MV: Yeah, no, we heard exactly the same in Asia. So they're like, okay, China is going away, but we're going to, I mean, there is a chance to substitute it with Middle East.

TG: Exactly. And the guy I had on earlier on the podcast earlier in the year, Richard Windsor, he basically did a piece with Bloomberg early last week saying much the same thing about Nvidia's earnings. Like everybody looks at the, oh, we're going to lose US$8 billion on China.

MV: Yeah, but there's more than US$8 billion to sell to Middle East.

TG: 100 percent. And I get that. It's fair to say it is the consensus position or was the consensus position. It's relatively expensive, although I think with the earnings picture we've seen from Q1, maybe you can justify that overvaluation is maybe less pronounced. And especially some of the capital flow trends we're thinking about in terms of the investment around the world into AI.

But nonetheless, I would posit that my skepticism is founded on that consensus risk as well as high expectations. But in the midst of high uncertainty in a trade war, what do you think it is about US stocks in particular and technology stocks more specifically that has made them more resilient?

MV: I mean, my key point for longer term equity investment has been for years and remaining is earning strength. It's quite incredible what AI has done for tech sector. It's pretty much made it almost like independent of the business cycle. So what we have with AI is a transfer of capital from non-tech sector into tech sector.

And yes, there would be winners and losers, and valuation is a question mark. But in terms of resilience of earnings, that's fantastic, it's really unparalleled to anyone. And right now, what we are facing is like huge uncertainty about earnings, about the cycle, about future growth, capex, anything and everything. You can really question which companies will be making money.

And I mean, tech is kind of, it keeps grinding higher and higher with actually quite good visibility of earnings going forward. That's really, really unusual. And I guess that's what investors are paying for, that's supporting us and really kind of sets it apart from any other market.

TG: What about the expectations? And this is admittedly a week or two old in terms of my looking at this, but one of the issues, because I think I'm still long, I didn't rotate out, I was not one of those people, I'm not that skeptical. And long term, I'm not skeptical at all. It was much more the sort of weights of positioning and expectations.

And I wanted to think about expectations here, because looking a couple of weeks ago, there's certainly been a lowering of expectations in non-technology sectors. And I'm going to come back to that. But for the technology sector itself, the expectations now for full year 2025 are actually slightly higher than they were at the beginning of the year, which was coming on the heels of two extremely good years for technology.

And so I wanted to see if you could talk about that and whether we will meet those expectations or exceed them, or if there is actually some potential for downgrades if we get a return especially of some of the things that drove volatility in recent months.

MV: I think with tech, I mean, obviously expectations are very high. But I mean, if you maybe take a step or two back in terms of where we are coming from, so tech earnings have been growing for good 30 percent for the last couple of years. And that's kind of why they perform so strongly. And at the end of last year, the big hope was earnings growth will broaden outside tech and other sectors will grow and tech earnings will naturally slow down.

If we look at Q1 earnings, so expectation I think ahead of earnings season were for 18 percent earnings growth. I mean, the latest numbers were like 30 percent plus earnings growth. So again, so we did not see that slow down.

Again, to me, what is really, really important for tech earnings and any earnings is like visibility of future earnings, right? So yes, outside tech, we're seeing slowdown, we're seeing slowdown in expectations, we're seeing uncertainty. And that was really kind of the key message in kind of post Q1 earnings is like nobody can give you any guidance. And that's really true for 10 out of 11 sectors in S&P.

So tech is the only sector that actually has very high expectations and consistently beat them, and it gives guidance, and it gives consistently strong guidance. So what we know kind of on the semiconductor side is that demand for AI is still very strong. We know also potential kind of chip wars with China are being substituted for the Middle East. And in general, so Nvidia talks about things that they have more demand than supply, so they choose their clients and things like that. And the only issue with revenue is kind of technical ability to produce as much. There is a ton of demand. So that side is fine.

And then we hear from all data centers and companies that develop AI is they continue to invest in capex, they see capex coming strong, they're not cutting back on that. So that is really kind of important in terms of businesses as normal, business is growing, we're not seeing slowdown. I mean, this volatility hasn't really done anything to take capex. So that's really encouraging. If you look across other sectors, what are the alternatives? And I mean, outside tech, it's very difficult to see this kind of dynamism in any other sector.

TG: I'm going to try one more line of questions on this. That's the retaliation threat. This is often brought up as another potential weight. And I wanted to see if you could address that, because of course we are in the midst still of a trade war. We don't know, as you alluded to, we don't know what this is going to look like for a variety of companies. We maybe have some that are somewhat insulated in the tech sector as you've alluded to. And that notion of having more demand than supply, I think, is really the key here.

That is what I can see very well makes it quite resilient. But what about that retaliation threat? These would seem to be targets as well as opportunities. And so I wondered if you could address that a little bit and how they stand with respect to that potential threat.

MV: I mean, a trade war, of course, makes everything unpredictable. As we said, strong demand is there. That's really helpful. But to me, what is like really interesting direction of thought and actually been, I mean, I just been on a trip to Asia. There are lots and lots of conversation about this idea that China tech is very much diverging from global tech. And they kind of develop their own ecosystem and that's potentially risky.

But that kind of sets out like American Western tech as a very separate animal and kind of beginning to behave on its own. So the big question is, okay, can we substitute China tech and all the potential revenues coming from there? And I think it's really interesting.

Tim, you've been following Donald Trump and Middle East since all the deals that were kind of made there. That's really interesting. And that's potentially transformational in terms of US having allied with very, very deep pockets who wants to align with US kind of technology ecosystem and it's being there. I think that's really important and that's long term, very long term kind of strategic support for US tech. So building out this ecosystem and potentially needing to compete less with China.

What is really interesting with DeepSeek, yes, it was really clever ideas, how quickly it was replicated by every technology company. I mean, ideas are easier to replicate. Hardware is much, much more difficult. And I always come back to kind of the childhood example of mine. I grew up in Soviet Union and the big arms race with our space race between Soviets and Americans was, so Americans spent, NASA spent, like billions of dollars trying to build a technology to have a pen that writes in space.

I mean, amazing technology. Russians took a pencil. So yes, there would be very cheap and interesting ways to come up with interesting solutions, but all those get replicated very, very quickly. So the hardware, the technology side is complicated, and that potentially wins markets and with wins hearts, but software and innovations that you get out of China, unfortunately, that's much harder to protect the intellectual property.

TG: Well, it's open source as well. It's dependent really on inferior silicon because they don't have access now to the chips that American companies and American allies will have access to.

MV: Yeah, I mean, the other example I make is that ASML to me is probably one of the most important companies in tech ecosystem to make those lithography machines. I mean, we say it's kind of a digital lithography machine company, but really it's like a global logistics company.

So it requires, I mean, the last time I looked, it requires nearly half a million of precise engineering parts that comes all over the world, and it would be extremely, extremely difficult for any country on its own, even as big as China, even as advanced as China, to come up with this technology in kind of foreseeable future. So I think this kind of retaliation threat and kind of China threats are probably not immediate.

TG: Before we quickly move on to some other questions, I had very big picture questions. Actually, I wanted to think about the 10 other sectors that you alluded to, and specifically think about the trade war risks that are priced in for those. We, of course, had a drawdown, quite sizable drawdown in Q1, and of course, after the “Liberation Day” tariffs were announced. But we've come roaring back thanks in large part to tech and the kind of buy the dip mentality does look as strong as ever.

We see this in our flows, which we're also going to talk about in a moment. But what about those other sectors? Do you think the risks are adequately priced and the expectations have adjusted, I guess, is the question. Have the expectations adjusted sufficiently to the downside for those sectors?

MV: I guess some faithful listeners probably remember that we were always far, far, far more excited about US tech than any other sector. And I mean, I was personally very skeptical about this idea of earnings broadening. So I think at the start of the year, there was a kind of consensus was there that that's increasingly going away, particularly kind of in terms of earnings expectation, in terms of ability to predict those earnings. So I mean, I hate saying it, but it almost doesn't matter. As long as tech grows fast enough as predicted, it's really marginal. It's a really marginal question. So I mean, I'm quite happy with kind of tech outlook. I think that's probably enough to support that question.

TG: That sounds like my line of thinking a year or two ago. I'll take credit for that.

MV: Yeah, exactly.

TG: So let's talk about what's going on right now, but then I want to think about the future and think about it in very big picture terms. I mean, I mentioned institutions are buying the dip in tech. Can you speak a little bit more about that in terms of just the scale of position building we're seeing again and what you're talking to clients about with respect to especially, of course, the institutional investor behavior metrics that we work quite closely with?

MV: A lot of thinking about what's happening with investor flows and holdings is really almost like you need to take again, once again, take a step back and at the start of the year, so investors have those enormous positions and overall equities. Most of it was US, most of it was tech. First four, probably four and a half months of the year, we've seen this huge, huge unwind in positions. Investors pretty much went close to benchmark. And I think that's an important point.

So they never went underweight risk, so they squared out their cyclical defensive position. Allocation to tech, it's been the biggest positions pretty much since TMT crisis. So almost 20 years ago, that was kind of towards the end of last year. And they went very close to benchmark. So this huge, huge unwind.

And a lot of like tech unwind to my mind is that, okay, we had huge uncertainty, we have trade war, we have huge volatility. So investors pretty much, I mean, they needed to de-risk their portfolio. They sell what they have, right? So it's not like the sector or assets that you expect to underperform, it's just what you have. And that's been a really kind of big money flow. Also, it almost kind of created momentum in investor behavior, right?

You overweighted something, like a big position, prices go down, you sell, prices go down even more. So it created this kind of almost self-fulfilling momentum.

Then around early April, what we saw, okay, trade war became trade negotiations. That was somewhat positive for the market. Reasonably stronger Q1 earnings were really important. So I think expectations were around like 4 or 5 percent growth in Q1, it was double that. And again, okay, companies won’t give guidance, but underlying earnings were still okay. So I think that gave investors a little bit more confidence in terms of coming back.

But what was always interesting to me is that, so we have a set of assets within tech sectors that has very, very strong underlying fundamentals, but they're extremely extensive. And then you have from quite a large set of assets, which was weak fundamentals, but trading at low multiples. And there is very little in the middle.

So what investors needed to decide is that, do they go for cheap or do they go for high quality? And it was really gratifying for us to see that investors stayed with better quality assets. Our big idea in our equity strategy team is to go for large-cap quality stocks. And a lot of them are in tech sector, and a lot of them are trading at the kind of very high multiples, but investors seem to be willing to pay those high multiples for good quality, good underlying fundamentals.

And to us, that's really important, particularly at times of uncertain earnings, uncertain global growth, when you can very easily imagine scenarios where earnings go down and margins come up. What investors basically telling us that we want to pay for quality, we want to pay for stability, we want to pay for safety, which is really ironic because in like normal times, when you want to get safety and stability, investors usually go for low beta sectors or defensive sectors, but they're not really safe anymore.

I mean, think about pharmaceuticals or with potential regulations, staples, with potential margins, with utilities, so all those sectors are not safe anymore. And arguably, as we discussed at the very beginning, so tech with being somewhat insulated from business cycle continues to receive inflows. Investors are gradually returning to the sector, but it's really, really important point that I keep stressing to clients that we've seen this enormous position unwind.

Investors coming back, we'll see flow still remain strong, particularly like in software and semiconductors, but positions have not recovered to those previous levels. So that makes outlook for the sector still fairly attractive.

TG: So you've jumped ahead and I was going to wait to ask this question at the very end, because it's a very big question, but what you've just said means I have to ask it now. And you talk especially about the safety of large cap growth. And look, I take that on board, and especially this year where you've had weakness in fixed income.

And just thinking very big picture portfolio construction at a high level asset allocation decision, you have equity market resilience in the face of bond market weakness. Now, that wasn't the case in April. It was a sell everything, raise cash, move to benchmark as you talked about type of environment.

But we have seen this resilience of behavior and price in equity markets and especially in the tech sector. And we have not seen the resilience in behavior and price and fixed income. Price is better, but behavior is still suggesting outflows, especially from highly indebted sovereigns like the US.

So the question that then comes to mind is, given the resilience, do we need to think differently about big picture questions like equity risk premia and the relative stability that equities has offered in this episode as potentially a feature of the landscape for years to come?

You have 30 seconds. No, take a couple of minutes, but that's a huge question that I think is a really important question.

MV: Yeah, no, I think you're absolutely right. It's really, really unusual for equities to be that resilient in face of bond sell-off and investor strikes against questions around, particularly US fixed income market. I think that's a really, really big question.

But I think I'm going to very much come back to what I said earlier, is that I wouldn't go that far as to say that equity, risk premium needs to be changed and everything, but things like tech. I probably would go as far as to argue that yes, we probably do need to rethink about tech sector, risk premium, what tech sector is giving us.

I mean, I find myself thinking that, I mean, we’ve liked the tech sector for almost a decade here. And it was because it was beta, it was growth, it was equity duration and whatnot. And now equity is your safety net. So we have those companies that are really stable and then can produce very strong and reliable earnings, almost kind of despite everything. So you have this huge questioning of the dollar, Treasury resilience, all those things, safe assets. But probably you don't have to question tech earnings, at least for now.

Ironically, the tech sector is often seen as one of the most risky assets and the proxy for risk is now the safest asset. So I think that changes the dynamic. But I probably wouldn't go as far as to say that all equity markets are like that, all risk premium are like that, so markets are, and that's to a large extent, kind of my concern about European and in 2004, European markets or Asian markets. So there you have a lot more question marks there. They are a lot more sensitive to kind of geopolitical tension, to business cycle tensions.

And then S&P ex Tech is exactly the same story. So there are lots and lots of headwinds and tailwinds shifting around, but US tech is quite a unique position. So maybe there we can kind of lower risk premium, but that's generally, I wouldn't say generally that's true for everything.

TG: Do you think, and this is one of the byproducts of the volatility episode we've seen the last couple of months, that needs of investors will change such that diversification becomes more important, and that, you know, not so much that fundamentals have to change for tech to underperform, but because there are underweights that you need to also pare back. What do you make of that?

MV: So we had this really interesting conversation with a client in Hong Kong about thinking of the need for diversification. What we saw in the last couple of years is very much that, or actually not even the last couple of years, probably close to a decade, when the biggest allocation was very, very concentrated in US tech, and the kind of diversification, even though that's absolutely quite correcting to do from an academic point of view, investors just really didn't do it.

We saw like very, very concentrated, but I guess Q1 was a kind of payback for the revenge of academia. But what is really interesting and probably would be like very interesting for us to see is that how long will that last? So yes, we've seen some diversification, but now kind of by the deep market is there and people are increasingly going back to the positions they had, right?

So when we look at our holdings, people go back to tech, people go back to stock, people go back to US. We're seeing outflows from Europe, we're seeing outflows from financials. So all we see outflows from defensive. So all those trades that investors kind of went to when they squared up position, they are beginning to disappear as well. 

But we'll see whether there will be at least some lesson investors take out of this episode in terms of needing to diversify. The jury is still out.

TG: What will it take then for this skepticism I've alluded to that has so far proven completely unfounded and as we've talked about, thankfully have not reallocated. But what does the world look like? I mean, the sky will be yellow, the sun will be blue, I'm sure, in that environment where tech starts to underperform, the US starts to underperform more meaningfully. What does it take to get there?

MV: Well, I wish I could share a chart with you, and maybe we can do it in Street Signs. But if you look at real earnings between US and all other regions, I mean, US earnings have more than doubled in the last decade. Real earnings more than doubled in the last decade, while the rest of the world is broadly flat. And a lot of it is tech, of course. And that's really why you have the strong performance of US stocks, of tech stocks relative to everything else.

So what needs to change for relative performance to change is that gap to start to start reversing. So for now, we still have substantially strong earnings, historical, expected margins, return on equity, whichever way you want to measure it in US and nowhere else. So once we begin to see that changing, then yes, we'll have to rotate.

And maybe like very early in the year, we have this MEGA trade, make Europe great again, and Europe earnings expectations have improved somewhat. But they never went ahead of US. So that's the challenge.

And just to give you an example, so US earnings growth for the whole market is 5-10 percent for the last few years. In Europe last year, it was minus five. This year, we're getting to zero. Next year, I think expectations are around low single digits. So yes, when Europe or any other region start outgrowing US., yes, of course, you need to... The sky will turn yellow and the sun will turn blue, but you need to see that happen.

TG: It will be a long wait.

MV: Well, and I think that's the real point, is that fundamentals are so much better and there is no really very good alternative. I think last year, that was very popular to talk about TINA trade. I think it's still the same. Where do you see earnings? Yes, those stocks are expensive, but they will stay expensive for as long as growth is scarce.

I mean, I've been on a long marketing trip and one very, how to put it, bright client says that the time of buying low and selling high kind of gone. You buy high and sell higher. I think that's the current market dynamic. For that to change, you need to have other sources of earnings growth.

When you have it all concentrated in US, which is already crowded and expensive, you kind of end up kind of sticking with it, but it's really uncomfortable. And actually what is really interesting, what current markets sell off kind of afforded clients is to reload on those positions. So overall holdings in US and tech have been around to a large degree, and now investors are reloading. But in terms of underlying fundamentals, we haven't seen big changes. We haven't seen earnings broadening. We haven't seen the US earnings story change. So we are staying with where we've been for the last few years.

TG: Go with what you know, Marija. Well, you're about to hop on to another flight. Your travels continue. Another couple of weeks on the road. I wish you the best, but I want to first say thank you so much, as always, for coming back and giving us yet another compelling case to not touch anything.

MV: Oh, thank you very much. You can always count on me being an insatiable optimist.

TG: When we can't, then we're definitely doing another podcast. But until then, you might not be a guest, because all I'll have to do is just keep repeating this one.

MV: Keep repeating it.

TG: Fantastic. Thanks, Marija.

MV: My pleasure.

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