Investment Strategy

U.S. stocks still lagging year to date despite recovery

This year continues to be a poster child for the benefits of diversification as the long-outperforming U.S. large-cap equities are still underperforming other major asset classes through the first five months of the year. The remainder of the U.S. equity space is not faring better, with mid-cap performance roughly the same as large caps and small caps still down year to date. Chart 1 shows that despite currently having recovered from the tariff-related drawdown to post a positive return through May, U.S. large-cap equities are behind international equities, fixed income, commodities, and even cash in year-to-date performance.

Chart 1. Asset-class performance through May shows value of diversificationSources: © Morningstar Direct, All Rights Reserved, Bloomberg, and Wells Fargo Investment Institute. Data from May 1, 2024, to May 30, 2025. YTD = year to date. Representative indexes include: MSCI EAFE Index, MSCI Emerging Markets Index, J.P. Morgan Emerging Markets Bond Index Global, Bloomberg Commodity Index, Bloomberg U.S. Corporate High Yield Bond Index, Bloomberg U.S. Aggregate Bond Index, Bloomberg U.S. Treasury Bill (1-3 Month) Index, Russell Midcap® Index, S&P 500 Index, and Russell 2000® Index. Performance results for Moderate Growth and Income, 50% global equities/50% global bonds, 50% U.S. equities/50% U.S. bonds are calculated using blended index returns and for illustrative purposes only. Moderate Growth and Income allocation is dynamic, and changes as needed with adjustments to the strategic allocations. U.S. equities represented by S&P 500 Index. U.S. bonds represented by Bloomberg U.S. Aggregate Bond Index. Global equities represented by MSCI All Country World Index (ACWI). Global bonds represented by Bloomberg Multiverse Index. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance does not guarantee future results. Diversification does not guarantee investment returns or eliminate risk of loss. The risk associated with the representative asset classes and the definitions of the indexes and the blended index compositions are provided at the end of the report.

While the recent trade developments have affected global markets, the impact thus far has been most significant on U.S. equities. Assets share key drivers, but certain factors may be more impactful for each. Thus, investors may benefit as the different assets within their portfolios potentially lower overall volatility. A weakening U.S. dollar, higher starting bond yields than were available in the years following the Great Financial Crisis, and the continued rise in the price of gold have benefited international equities, fixed income, and commodities, respectively, despite the uncertainty related to tariffs and other policies. Diversified portfolios, such as the balanced Moderate Growth & Income (MGI) allocation, which roughly aligns to a 50% fixed income and 50% equities breakdown, have benefited from the broadened leadership in performance. While U.S. large-cap equities are doing significantly better over the past year, they are still underperforming both emerging- and developed-market equities, with diversified portfolios remaining competitive while also providing lower volatility risk. Looking forward, we do expect U.S. large- and mid-cap equities to resume their strong performance in the long term, and so we maintain our bias toward U.S. assets.

The MGI allocation (+3.3%) has outperformed U.S. large-cap equities (+1.1%) so far this year. However, the path matters, as only looking at end-to-end returns glosses over the 19% peak-to-trough decline in the S&P 500 Index between February 19 and April 8. While ups and downs in asset values are to be expected and should be accounted for during an investor’s financial planning, they can still have a significant psychological impact. As Chart 2 illustrates, smoother performance of a diversified portfolio not only avoided the depth of the March/April drawdown in the S&P 500 Index this year but also allowed the MGI portfolio to recover sooner than the S&P 500 Index. While periods of market volatility can be stressful for investors, they are also a great reminder of the value that proper allocation selection and diversification can potentially offer.

Chart 2. The S&P 500 Index has underperformed a diversified portfolio and had more volatilitySources: © Morningstar Direct, All Rights Reserved, Bloomberg, and Wells Fargo Investment Institute. Data from January 1, 2025, to May 30, 2025. *Indexes are set to 100 as of closing prices on December 31, 2024. Performance results for Moderate Growth & Income is calculated using blended index returns and for illustrative purposes only. Moderate Growth & Income allocation is dynamic, and changes as needed with adjustments to the strategic allocations. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance does not guarantee future results. Diversification does not guarantee investment returns or eliminate risk of loss. The risk associated with the representative asset classes and the definitions of the indexes and the blended index compositions are provided at the end of the report. 

Upgrading Utilities, downgrading Consumer Discretionary

Recently, we upgraded the Utilities sector from unfavorable to favorable. We believe the sector offers a unique combination of both defensive and offensive traits. The sector may hedge against further market volatility and downside economic risks. Additionally, as it is composed of primarily domestic businesses, the sector should be less affected by tariff and currency risks. Another positive for investors is that the sector is an integral part of the strong, long-term demand for power that we expect from the artificial-intelligence- (AI-) related data-center buildout. Valuations appear fair in our view, and forward earnings growth, revisions, and breadth have bested nearly all other sectors.

We paired the Utilities upgrade with a downgrade of the Consumer Discretionary sector. The AI story will likely be a tailwind, although we much prefer the Information Technology and Communication Services sectors — both rated favorable — as ways to gain exposure to that theme. The economic slowdown and below-trend economic rebound we forecast is likely to weigh on the more cyclical areas of Consumer Discretionary. A shallow Fed rate-cutting cycle is likely to offer little boost to activity while tariff costs could be significant and strain the sector and consumer. We view the risk-reward balance as unattractive and downgraded the sector from neutral to unfavorable.

Table 1. Equity sector guidance

Sector	Guidance
Communication Services	Favorable
Consumer Discretionary	Unfavorable
Consumer Staples	Unfavorable
Energy	Most Favorable
Financials	Favorable
Health Care	Neutral
Industrials	Neutral
Information Technology	Favorable
Materials	Neutral
Real Estate	Neutral
Utilities	Favorable

Source: Wells Fargo Investment Institute as of June 9, 2025.

High bar for Fed interest-rate cuts in the near term

As the Federal Open Market Committee (FOMC) prepares for its June 17 – 18 meeting, it continues to face a high bar for being able to deliver further interest-rate cuts. Commentary from Chair Jerome Powell and minutes from the FOMC’s meeting in May indicate an even balance between the FOMC’s two main goals, inflation and unemployment, as well as its belief that policy interest rates remain at an appropriate level relative to the current state of the U.S. economy.

In our view, the current economic environment makes it difficult for the Fed to justify rate cuts. Incoming economic data remains relatively robust in spite of rocky consumer sentiment. Furthermore, Chair Powell has publicly discussed concerns regarding the future impacts of tariffs on inflation, potentially discounting favorable inflation data in recent months. Any changes on these two fronts would likely need to be sustained to change the Fed’s outlook, meaning that barring massive economic shifts, months of poor economic data and favorable inflation outlooks would be required to green-light cuts.

Given this outlook, we continue to believe that for now, interest-rate cuts at the upcoming June or July FOMC meetings are unlikely. The chart below demonstrates that market expectations for the federal funds rate in these months have increased over the past year, indicating the perceived rising difficulty of cutting in the near term. Even cuts in September may prove to be difficult without more economic softening or progress on tariffs.

Market-implied federal funds rate for upcoming Fed meetingsSources: Bloomberg and Wells Fargo Investment Institute, as of June 3, 2025. Market-implied federal funds rate derived from futures market pricing of federal funds rate as of a given date.

We believe the difficulty of the Fed’s rate outlook is a potential source of volatility in yields. We do not believe current rates in U.S. Long Term Taxable Fixed Income properly compensate for a number of potential sources of volatility, and we are unfavorable on the asset class. We see U.S. Intermediate Term Taxable Fixed Income as displaying a better mix of upside yield opportunities with lower interest-rate risk. 

Checking in with Dr. Copper

Copper is often touted for its ability to gauge economic health due to its widespread usage across the global economy — especially within areas that are more cyclically sensitive. For this reason, copper is often referred to as “Dr. Copper”. One way to view this relationship is to compare the copper-to-gold ratio against The Conference Board’s Leading Economic Index, which historically rises amid economic strength but falls as economic concerns arise and investors turn risk-off.

Unsurprisingly, the ratio continued to decline in 2025 as investors flocked to assets, like gold, amid uncertainties around tariffs, geopolitics, and a slowing economy. This risk-off sentiment has been a headwind for cyclically sensitive commodities, such as Energy and Industrial Metals, while benefiting other sectors, like Precious Metals.

In the short run there can be disconnects between the copper-to-gold ratio and the Leading Economic Index, but the general trend has been for a lower index in 2025. This trend is consistent with our expectation for the U.S. economy to enter a soft patch before improving modestly in the later part of the year and through 2026.

What this means for investors is that Commodities, and specifically cyclical sectors like Industrial Metals, could experience periods of volatility or price weakness in the near term as economic softness persists. This is one reason as to why we remain neutral on Industrial Metals. However, as economic conditions improve later this year and we expect to see the economic outlook inflect higher, we believe there could be opportunities for the sector to become a relative outperformer. In an effort to position for this cyclical rebound, we recommend that investors hold a full allocation to a broad basked of commodities, which includes exposure to Industrial Metals.

Copper-to-gold ratio and the Leading Economic Indicators Index Sources: Bloomberg and Wells Fargo Investment Institute. Daily data from January 31, 2008 – June 1, 2025. The Leading Economic Index is a monthly index. YOY = year over year. Past performance does not guarantee future results.

Merger and acquisition recovery stalls amid uncertainty

For most mergers, the acquirer offers to pay a premium to the target company’s current stock price. While a majority of the spread (between the offering price and current price) converges quickly after the announcement, a portion of the premium often persists and is dependent on the successful completion of the merger. Most Merger Arbitrage sub-strategies attempt to capture this post-announcement spread.

The amount of deal activity remains a key driver of performance for these strategies and is influenced by the cost of financing, potential regulatory risks, and the confidence of corporate leadership in its outlook for the economy. While optimism was growing in early 2025, the recent tariff-induced market volatility has slowed deal activity considerably. The uncertainty around the level and potential implications of tariffs have led to a decline in the confidence of corporate leadership, likely contributing to fewer deals as the economic outlook grew increasingly murky. As a measure of corporate-leader confidence, the CEO Confidence Index registered one of the largest drops in the history of the index, which dates back to 2003 (see chart). We believe a resumption of the recovery in deal activity will greatly depend on the depth and length of the multi-front trade war. If the resolutions with major trading partners occur in the coming months, we expect that corporate-leader confidence may erase much of the recent decline. Yet, we believe a more prolonged negotiation cycle may lead to greater negative economic consequences and a further delay in any recovery in M&A activity.

We believe that the environment for Merger Arbitrage sub-strategies should continue to improve, yet we will need to see further improvement in many of these areas to warrant an upgrade from our current neutral guidance.

CEO confidence drops as trade uncertainty roils marketsSources: Bloomberg and Wells Fargo Investment Institute. Data shown from November 30, 2002 – April 30, 2025, as of April 30, 2025. Chief Executive Magazine surveys Chief Executive Officers (CEOs) each month to compile their CEO Confidence Index data. The CEO Confidence Index value is a rating from 1 to 10 of CEOs' expectations for overall business conditions. As such, it captures an accurate assessment of how confident CEOs are in the economy and prospects for business over the coming year. CEOs are guided by giving them the following word associations to each value: 10 = Excellent, 8 = Very Good, 6 = Good, 4 = Weak, 2 = Poor.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, June 9, 2025.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Investing in gold, silver or other precious metals involves special risk considerations such as severe price fluctuations and adverse economic and regulatory developments affecting the sector or industry. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

Moderate Growth and Income: 2% Bloomberg U.S. Treasury Bills (1–3 Month) Index, 30% Bloomberg U.S. Aggregate Bond Index, 6% Bloomberg U.S. Corporate High Yield Bond Index, 5% J.P. Morgan EMBI Global, 27% S&P 500 Index, 10% Russell Midcap Index, 3% Russell 2000 Index, 8% MSCI EAFE Index, 5% MSCI Emerging Markets Index, 4% Bloomberg Commodity Index.

50% global equities/50% global bonds: 50% MSCI ACWI/50% Bloomberg Multiverse Index.

50% U.S. equities/50% U.S. bonds: 50% S&P 500 Index/50% Bloomberg U.S. Aggregate Bond Index.

An index is unmanaged and not available for direct investment.

Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements.

Bloomberg Multiverse Index provides a broad-based measure of the global fixed-income bond market. The index represents the union of the Global Aggregate Index and the Global High-Yield Index and captures investment grade and high yield securities in all eligible currencies.

Bloomberg U.S. Aggregate Bond Index is composed of the Bloomberg U.S. Government/Credit Index and the Bloomberg U.S. Mortgage-Backed Securities Index and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities.

Bloomberg U.S. Corporate High Yield Bond Index covers the U.S. dollar-denominated, non-investment grade, fixed-rate, taxable corporate bond market.

Bloomberg U.S. Treasury Bills (1-3 Month) Index is representative of money markets.

Conference Board Leading Economic Index is an index that is compiled by the Conference Board, a private-sector consulting firm. The index is a composite of economic measurements as was designed in an effort to track and forecast changing patterns in the economy.

CEO Confidence Index value is a rating from 1 to 10 of CEOs' expectations for overall business conditions. As such, it captures an accurate assessment of how confident CEOs are in the economy and prospects for business over the coming year. CEOs are guided by giving them the following word associations to each value: 10 = Excellent, 8 = Very Good, 6 = Good, 4 = Weak, 2 = Poor.

J.P. Morgan Emerging Market Bond Index (EMBI) Global is a U.S. dollar-denominated, investible, market cap-weighted index representing a broad universe of emerging market sovereign and quasi-sovereign debt.

MSCI All Country World Index (ACWI) is a free-float-adjusted market-capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets.

MSCI EAFE Index is a free-float-adjusted market-capitalization-weighted index designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index is a free-float-adjusted market-capitalization-weighted index designed to measure equity market performance of emerging markets.

Russell Midcap Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25% of the total market capitalization of the Russell 1000 Index.

Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.

S&P 500 Index is a market capitalization-weighted index composed of 500 stocks generally considered representative of the U.S. stock market.

S&P 500 Utilities Index comprises those companies included in the S&P 500 that are classified as members of the GICS utilities sector.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

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