Throughout 2024, global growth has been remarkably stable and has now started to rise in recent months. While the global industrial sector has been in recession, with weak underlying demand and global trade flows flattening, this has been more than offset by resilient domestic demand and service sector activity. As we head into 2025, the global economic cycle is approaching an important inflection point. While the impact of a new Trump administration and potential future China stimulus measures remains to be seen and risks remain, growth seems poised to accelerate, especially in the US. However, it’s worth reflecting on just how much the environment has changed for equity investors. 

A fundamental reversal

Since the end of the global financial crisis (GFC), low if not outright nonexistent inflation gave central bankers free range to flex their monetary muscles in unison to backstop economic growth whenever necessary. In this highly synchronized world, equity markets tended to move in tandem, providing little scope for diversification to add value. In a world where correlations were high but nominal growth and the cost of capital were very low, the key to equity market outperformance was in identifying the companies or business models with superior growth.

When inflation suddenly reemerged in the post-pandemic environment, monetary policy dramatically reversed. Negative or 0% interest rates moved sharply higher and quantitative easing shifted to quantitative tightening. Policymakers must now battle a constant trade-off between economic growth and inflation, meaning that monetary policy will need to be structurally more restrictive.

Meanwhile, the global economy is simultaneously facing several other interrelated changes. Globalization is slowing (or even reversing) as geopolitical and trade tensions increase, with policymakers becoming more domestically focused and interventionist. And fiscal policy is playing an increasingly critical role as governments seek to resolve some of the structural imbalances introduced by the prior monetary-driven regime. 

With these shifts in mind, in 2025, we see five themes that may create opportunity across global equity markets.

1) Is the broadening of equity market performance likely to continue?

Strong earnings growth, driven by advancements in AI, has propelled the "Magnificent 7" group of tech mega caps to remarkable gains, leaving the rest of the market trailing in their wake. The second half of 2024 marked the beginning of broader earnings growth beyond the mega caps. The combination of a general broadening of economic growth, lower inflation, and lower short-term interest rates is benefiting a range of sectors across the market capitalization spectrum. Another factor for consideration: 2025 will see mega caps earnings measured against two years of extremely fast growth and high profit levels, whereas the rest of the market will experience more favorable comparisons to two years of profit recession. 

This broadening of growth — alongside increased dispersion, lower correlations, and higher volatility — should create stock-picking opportunities for dynamic investors.

2) Is there renewed value in diversification?

In the post-GFC period, central banks around the world tended to take the Federal Reserve’s lead in cutting or hiking interest rates. This not only created synchronized economic cycles but increased correlation between regional equity markets, reducing the benefit of regional diversification.

Looking ahead, however, we now expect that inflation will not only be structurally higher but also more variable across countries. This is likely to result in desynchronized economic cycles as central banks adjust rates to combat specific issues faced by their economies. The divergent monetary policy cycles of Japan and continental Europe exemplify this trend. While both regions have structurally similar economies, Japan is only at the beginning of a hiking cycle, while Europe is in the middle of an easing cycle. 

This trend is already playing out in equity markets, where cross-country correlations are at a 20-year low . A globally diversified approach should have greater value in this environment, and more dispersion between regions could create opportunity for active investors, especially in 2025 as the Trump 2.0 policy agenda takes shape. 

3) Do we need to go beyond regional diversification?

As we say, the combination of more divergent monetary policy and more domestically focused and interventionist policymakers will likely translate into new forms of regional divergence. However, we believe investors may wish to also look for diversification beyond the country factor. Unlike 20 years ago, where a stock is listed is now no longer a primary determinant of performance. Over time, stocks have become more correlated to the sector or theme they belong to than the region. There are two reasons for this. Firstly, large caps have become more international. Secondly, thematic investing has grown in popularity as investors seek to align their portfolios with the long-term structural changes of economies. 

In this environment, regional diversification remains important but investors should also ensure sufficient diversification across themes that span economies, such as thematic strategies that focus on parts of the market that are expected to benefit from structural change, for example, global security, automation, the energy transition, and medical innovation. AI will remain a key theme in 2025, but Trump’s policies will take center stage, creating scope for significant dispersion and uncertainty in markets. For equity markets, the implications could be complex and far-reaching, encompassing both potential headwinds and tailwinds, such as tariffs, stricter immigration controls, and a partial or full repeal of the Inflation Reduction Act on the one side and deregulation, lower taxes, lower spending, and more M&A on the other.

4) Could Europe be a stock picker’s paradise? 

Europe is, in our view, currently undergoing a significant regime shift, reminiscent of the changes seen in 2000 and 2008, potentially making European equities particularly appealing for active investors. This shift is driven by three key developments:

• Globalization is slowing as geopolitical and trade tensions increase. Europe’s open economy means it is particularly impacted by this shift.
• After a decade of exceptionally loose monetary policy, Europe is transitioning to a more restrictive monetary environment.
• Europe is a highly open economy but it is growing more domestically focused and interventionist, with national security and the energy transition becoming central to policymaking. Demographic shifts and a return to positive interest rates are also contributing to this change.

We believe these factors will significantly impact European financial markets and equities. We anticipate structurally higher inflation and interest rates, increased political intervention, a renewed emphasis on valuation, and a decline in the relative attractiveness of international exposure.

We believe the primary beneficiaries of this regime shift will be sectors within the value space, such as European banks and telecoms, defense stocks, and European small caps. Conversely, sectors that have benefited from globalization and lower interest rates are likely to face challenges.

5) Could 2025 see greater value in small- or mid-cap companies?

Over time, small-cap stocks have outperformed large-cap stocks, due to the fact that small companies have historically grown faster than large companies. While there is no guarantee that historical patterns will hold, leadership between small caps and large caps tends to alternate, with cycles that typically last between 10 – 15 years. Small caps have now underperformed for more than 13 years, resulting in a historically wide valuation discount relative to large caps. 

Part of the reason for this underperformance is small caps’ greater sensitivity to economic conditions and rising interest rates, which has meant their earnings have been disproportionately negatively impacted over the last two years. We believe a broadening in economic growth, lower inflation, and reduction in interest rates could start to lift the earnings headwind small caps have faced for the last two years and will be watching to see whether sales and profit growth begin to normalize. Should this be the case, we think the disparity and dispersion within small caps make this asset class particularly attractive for active managers, particularly across the US and Europe. We will also be watching to see if a new Trump administration results in deregulation and increased M&A. This could be beneficial for certain areas within the small-cap market, depending on the nature of any policies. Furthermore, small-cap equities are generally a less-efficient part of the market than large-cap equities, creating opportunities to identify undervalued stocks.

Bottom line

As we look ahead to 2025, the global equity landscape is poised for dynamic shifts. With the broadening of earnings growth, renewed value in global diversification, and the potential of small- and mid-cap companies, we see the potential for compelling opportunities.

Overall, a more strategic and diversified approach, with a focus on identifying undervalued opportunities across sectors and regions, will be essential for navigating the evolving investment landscape in 2025.

Our capabilities

Republication or redistribution of Refinitiv content, including by framing or similar means, is prohibited without the prior written consent of Refinitiv. Refinitiv is not liable for any errors or delays in Refinitiv content, or for any actions taken in reliance on such content. Refinitiv’s logo is a trademark of Refinitiv and its affiliated companies. www.refinitiv.com

Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties herby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including loss of profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’S express written consent.

¹ Bloomberg Finance LLP, June 2024