Good morning! I’m publishing a little later than usual, but hopefully better late than not at all!

We got some potentially narrative altering data last week that could suggest the U.S. economy is slowing. Plus, the markets continue to shift in a more defensive direction.

What We're Talking About This Week!

• Quick Hits For The Week Ahead

• Dividend Landscape

• Top 10 List

• Looking Ahead

Quick Hits For The Week Ahead

Among the major events that took place last week:

• U.S. composite PMI plunged for the second straight month, including the services sector contracting for the first time in two years

• The housing market is showing signs of weakening further

• International stocks remain red hot

• Japan inflation is getting out of control

• Magnificent 7 leadership is officially done

U.S. equities are turning defensive despite the S&P 500 sitting near highs

Up until the latter part of last week, the major U.S. averages continued to test new highs. Under the surface, however, has been a major shift in what’s driving the averages higher.

Gone are the days where the magnificent 7 stocks were able to single handedly pull the S&P 500 higher. Of the 16 factors I monitor on a regular basis, the magnificent 7 would rank as the 2nd worst performer year-to-date if they were inserted into the list, topping along the wide moat factor.

Over the past month, the best performing sector has been communication services, led higher by the impressive rally from Facebook. The next best performers beyond that - consumer staples, healthcare and real estate. Utilities have slightly lagged the S&P 500, but they’ve also been picking up over the past few weeks. The top performing factors over the past month - quality, low volatility and value.

Even though investors aren’t abandoning stocks altogether, they’re definitely pivoting within them. Growth isn’t out altogether as there are some pockets of strength, but this has definitely changed into a market where defense is prevailing and previous winners are getting shunned.

Investors are starting to give China equities a look

The outperformance from international stocks is hitting the two-month mark and isn’t showing much sign of slowing down. This is their best stretch of outperformance since October 2022 - January 2023. Emerging markets didn’t start outperforming until just recently, but they’ve beaten the S&P 500 by nearly 7% in just the past month. Given how some of the important data in the U.S. may be starting to break down, conditions are setting up for this trend to continue.

One area that’s getting particularly interesting is China. It’s been a toxic market pretty much since the COVID pandemic started, but I’m starting to get the sense that the worst of the news has been priced in. The DeepSeek revelation may have helped put China back on the map in the AI race. The Chinese tech sector has been off to the races and with a bottom in the real estate market and a stimulus package potentially in the offing, there’s are good reasons why China stocks are hot at the moment.

China ETFs have taken in more than $1 billion in the past month, a big number considered the whole group only accounts for $27 billion.

There’s no question that China and emerging markets stocks are cheap right now. The falling dollar has added a tailwind and value stocks beginning to outpace growth stocks may finally be positioning China to have a run.

The markets have handled tariffs & layoffs in stride…so far

Despite a lot of threats, the 25% tariff on steel & aluminum imports and a 10% tariff on Chinese goods is all that’s been implemented thus far. Canada and Mexico tariffs have been delayed, probably for some time if I had to guess. Europe’s been a supposed target, but there’s been nothing concrete there either. While those tariffs are inflationary, I don’t think that’s going to be enough to meaningfully drive inflation higher.

The DOGE layoffs are scary for a lot of people, but from a 30,000 foot view, they haven’t had a meaningful impact on the overall labor market (except in select markets, such as Washington DC). The government is the country’s largest employer and depending on how draconian these job cuts get, it’s entirely possible, maybe even reasonable, that the labor market takes a hit more broadly, but that might take a little time.

Neither of these events, however, seems to be creating much of a ripple in the markets outside of a modest pivot to more conservative equities. Bond yields have fallen, but not to the degree that would suggest a flight to safety trade. I think this is probably a fair response at this point.

The situation in Japan is getting complicated

Japanese inflation hit 4% in January, up from 2.3% annualized just in October. The BoJ finds themselves in an increasingly difficult spot. GDP growth has been solid and trending in the right direction and that might give the central bank an opportunity to be more aggressive. Governor Ueda indicated that the plan is still to take a measured approach, which sent bond yields lower last week, but given the trajectory of inflation, their hand may be forced soon.

Dividend Landscape

The outlook for dividend stocks relative to the broader market continues to improve. They’re now outpacing the S&P 500 by more than a full percent year-to-date, but it’s interesting that none of the primary factors - dividend growth, dividend quality and high yield - are doing particularly well on their own this year.

Perhaps it’s just the garbage that’s getting more play.

Prior to last week, dividend stocks were gaining some momentum on investor sentiment shifts as much as anything. Last week, they got the data that could confirm their fears.

If the data continues to trend in the direction that suggests a broad economic weakening is upon us, I suspect this group will do much better quickly (at least on a relative basis).

Top 10 List

Let’s take a look at a handful of ETFs worth highlighting (just going to do five this week):

Vanguard S&P 500 ETF (VOO)

VOO officially passed the SPDR S&P 500 ETF (SPY) as the largest in the world at one point last week (although it’s back to trailing slightly again as of Friday). Given years of net flow trends, it’s only a matter of time before it stays ahead for good (and the iShares Core S&P 500 ETF (IVV) passes it as well).

As I’ve mentioned before, VOO and IVV are better for long-term investors. SPY is better for frequent traders.

iShares MSCI Emerging Markets ex-China ETF (EMXC)

If you’re leery on China and prefer to stay away, this ETF would be your option for still investing in emerging markets. Because China has done so well in 2025, it’s trailing the traditional EM indices year-to-date, but it also consistently outperformed them in the four years prior to that.

PGIM Ultra Short Bond ETF (PULS)

In the ultra-short bond category, PULS is still one of my favorites. It’s an actively-managed fund, which I think is the way to go in this market. Its 0.15% expense ratio is comparable to that of many index funds, so you’re essentially getting the active management for free. It’s among the best performers in this category both year-to-date and over the past year. Plus, it’s got a 5-star Morningstar rating.

Invesco Nasdaq Next Gen 100 ETF (QQQJ)

If you’re still interested in the Nasdaq, but are leery of the magnificent 7 underperforming, this might be an ETF worth considering. Whereas the QQQ invests in the largest 100 Nasdaq stocks, QQQJ goes after 101-200. It still has a 35% allocation to tech, but it’s much heavier in mid-caps, a group that is doing particularly well right now.

Invesco KBW Bank ETF (KBWB)

If you’re a Buffett follower, you probably heard that he’s been raising cash again. He trimmed his S&P 500 holdings in Q4, but also sold some of his Bank of America and Citigroup positions. Most investors think the Financial Select Sector SPDR ETF (XLK) is the best way to target this sector, but KBWB does a much better job of focusing on the big banks.

Looking Ahead

Looking better for: Japanese yen, consumer staples, wide moat

Looking worse for: China, communication services, junk bonds

If you have any more thoughts, feel free to jump into the comments below!