While equity markets aren’t the economy, they should reflect the economy. When the broad collection of publicly traded companies in a market grows so much faster than GDP, we think it indicates an imbalance in capital allocation trends that may not be rooted in reality. Just as a company’s share price may become detached from its fundamentals, an equity market that’s out of sync with the real economy points to a distortion that could unwind.
Signs of Change in Early 2025
Market trends in early 2025 could herald a rebalancing of global equity-market returns, in our view. The starting point is the heavy concentration of US equities in a small group of mega-cap stocks.
By the end of the first quarter, the Magnificent Seven accounted for almost a third of the S&P 500’s $51.8 trillion market capitalization. During the first quarter, returns among the mega-caps diverged amid growing scrutiny of their earnings power. To be sure, the Magnificent Seven as a group did better in the second quarter, suggesting that a potential reduction of market concentration won’t unfold in a straight line. If technology disruptors are disrupted over time and US market concentration unwinds further, we expect to see more rebalancing toward non-US stocks.
During the first half of 2025, US stocks underperformed global markets amid growing concern that Trump’s tariff policies could trigger an economic slowdown that might curb US consumer spending. Increased defense spending in Europe and Japan also helped boost non-US markets. European and emerging-market stocks have done particularly well, outpacing the S&P 500 through early June.
The underperformance hasn’t gone unnoticed by those closest to the companies. During the first quarter, US corporate insiders sold shares of their own companies at a faster pace than we’ve seen in two decades, according to a recent Financial Times analysis. This implies that insiders themselves may be questioning whether the days of unbridled US outperformance may be nearing an end.
Catalysts for Change
What needs to happen for non-US stocks to post a sustained recovery? As mentioned earlier, low valuations aren’t enough. To some extent, US policies could continue to help spur fund flows away from the US if tariffs inflict significant damage on American companies and the economy. Increased fiscal spending in Europe and Japan and Japan’s long-awaited exit from persistent deflation could also be catalysts for non-US equity returns and fund flows. A shift in flows could become a virtuous circle, boosting returns in Europe, Asia and emerging markets, which would draw more capital and investors away from the US over time.
Cracks are already appearing in the market. US stocks underperformed non-US stocks this year through mid-June. The cost of credit default swaps on US sovereign debt has risen recently to a relatively high level, which suggests eroding confidence in the US as a safe-haven investment destination. Meanwhile, the 30-year US Treasury yield has risen sharply while the weakening US dollar is widely expected to continue its decline. Taken together, these developments imply that the risk level of US equities has risen.
Nobody can predict how a potential revival of non-US stocks might play out. As we see it, the key to capitalizing on a change in sentiment is to be selective by identifying companies with quality businesses and overlooked earnings growth potential, which will likely lead a long-term recovery. Since non-US stocks have been unloved for so long, companies with strong fundamentals can be found across the market—from value and growth equities to defensive stocks. Investors with different risk appetites can discover multiple paths to capture a potential broadening of regional return patterns in equity portfolios.
