US inflation risks and policy uncertainty keep pressure on US markets as defensive plays gain ground
A sharp pullback from US equities in July sent US$13.6bn into global ex-US equity funds, the largest monthly inflow since December 2021, as per LSEG Lipper data reported by Reuters.
The rotation came amid concerns over economic conditions, stretched valuations, and a weakening US dollar, with Europe and emerging markets attracting increased interest due to easier monetary policies and stronger growth prospects.
According to Reuters, US-focused equity funds saw US$6.3bn in outflows in July, marking a third straight month of redemptions. This shift has been building since early 2025, when US President Donald Trump’s economic policies began to erode the appeal of US markets.
Shelton Capital Management Chief Investment Officer Derek Izuel noted that unresolved trade negotiations and looming policy deadlines in the third quarter could drive further outflows if growth gaps narrow or the Federal Reserve maintains a restrictive stance.
Performance disparities have played a role, with the MSCI Asia Pacific ex-Japan index up about 14 percent and the MSCI Europe index gaining more than 19 percent this year, both outpacing the S&P 500’s 7.2 percent rise.
The US dollar’s roughly 10 percent decline has amplified returns for US-based investors in overseas markets.
Valuation differences are also stark, with the forward 12-month price-to-earnings ratio at 22.6 for the MSCI US index compared with 14.4 for MSCI Asia, 14.2 for MSCI Europe, and 19.7 for MSCI World.
From an inflation perspective, S&P Global reported that the July US Consumer Price Index (CPI) rose 2.7 percent year-on-year, unchanged from June and below market expectations.
This strengthened market conviction for a September interest rate cut, with CME FedWatch showing nearly full pricing compared with 86 percent before the CPI release.
However, core CPI rose in July, and S&P Global’s PMI Output Prices data suggest inflation could approach 4 percent in coming months, driven by higher tariffs.
This scenario could limit the Federal Reserve’s scope for further rate cuts even if the September move materialises.
The S&P Global Investment Manager Index (IMI) survey at the start of August showed central bank policy shifting from a positive to a neutral factor for US equity returns.
Investors’ concerns over both global and domestic macroeconomic conditions increased, reinforcing a more defensive approach.
Sector allocations reflected this, with utilities gaining favour, consumer staples seeing reduced bearish sentiment, and basic materials turning from bullish to bearish.
Financials, communication services, and tech remained leading sectors but with lower bullish conviction.
Growth stocks remain supported by PMI data, which typically favours them during periods of economic expansion.
However, S&P Global cautioned that tariff-driven inventory gains in early 2025 may reverse toward year-end.
Their PMI-based indicator also signalled a ‘sell’ on the US dollar for August, aligning with its decline since early in the month, following a profitable ‘buy’ signal between July and August.
