The dynamics of equity markets are changing. The focus is shifting from the dominance of a few major tech companies to much broader market participation. A republican victory in the U.S. is likely to continue this trend and while emerging markets are presenting unique opportunity, potential tariffs require careful selection. At the same time, U.S. policy, geopolitical tensions, U.S. and Japanese monetary policy, and China’s stimulus efforts have the potential to increase market volatility and dispersion in the near term. However, the broadening of market returns we have witnessed since the July U.S. CPI print is likely to continue.

"...the broadening of market returns we have witnessed since the July U.S. CPI print is likely to continue."

Tech earnings growth peak, while the rest of the market reaccelerate

Market performance and earnings growth have been concentrated among a small cohort of companies, dubbed the “Magnificent Seven” (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta Platforms, and Tesla) or “Mag 7.” Their returns have been heavily influenced by artificial intelligence (AI)‑linked growth. Innovations in health care, and specifically GLP‑1s, have also seen select companies benefit. These powerful investment trends remain, but fundamentals matter and peaking earnings growth for some of these companies point to change and lessen their appeal for investors.

Figure 1 illustrates how earnings for the Mag 7 collectively peaked in the fourth quarter of 2023, while the rest of the companies in the S&P 500 Index appear on the cusp of earnings reaccelerating. By second quarter 2024, the S&P 500 Index excluding the Mag 7, or the “S&P 493” as they have come to be known, returned to positive earnings growth following five straight quarters of declines or stagnation. The diminishing dominance of the “Mag 7” has led to a rotation in sector leadership, but also coincided with mid‑year volatility, a shift to defensive positioning, and increased prospects for Fed rate cuts (Figure 2). Although still in its infancy, we expect this trend to continue into 2025.

There is also a change afoot within the Mag 7 itself. The year 2024 hasn’t been nearly so dominant for this group. With the peak in earnings growth likely behind us, their appeal has deteriorated versus a broader market that is seeing earnings reaccelerate.

A Republican victory in the U.S. is expected to further fuel the broadening of market performance, with an overall stimulatory agenda, protectionist policy, and potential for reduced regulation favoring a wider range of U.S. companies and overall being seen as positive for domestic economic expansion. This is in contrast to a recent period of U.S. economic concerns. In our experience, fundamental momentum matters more in the short term for relative market performance, and we expect this to result in continued divergence of the Mag 7 performance.

To be clear, however, these are high‑quality companies that have delivered strong profitability and free cash flow, but given their high concentration levels within market indices, we believe careful risk management of this cohort is required. We continue to treat this collective set of companies as a sector, with stock selection driving over/underweights within this group but maintaining a relatively neutral weight collectively.

At the same time, while there is a debate on whether the infrastructure and investment cycle for AI may be peaking, we do believe we are only scratching the surface in terms of the potential benefits and use cases for AI. The market may question the return on investment on AI in the near term, but we expect continued innovation and productivity to come through as companies develop their AI capabilities. This is a megatrend that is real and is not going away.

Emerging markets shouldn’t be overlooked

Emerging markets—which were prominent in many portfolios throughout the 1990s and during the BRICS¹ era—have been deeply out of favor since the global financial crisis. However, they are starting to show early signs of recovery. Emerging market equities have undergone a massive derating since 2008. They trade at around a 35% discount to their developed market (DM) peers,² and their weight in global indices has plummeted. Since the pandemic, things have gone from bad to worse. Emerging market shares have been hit by a strong dollar as U.S. interest rates rose and stayed higher for longer; they have suffered from the dire performance of the Chinese economy and stock market since 2021, and in the last few years have been weighed down by general risk‑off sentiment among investors and a rise in geopolitical tensions. Now, investors have the added uncertainty of anticipated tariffs from the new U.S. administration.

But China woes and U.S. dollar strength have been clouds hanging over an opportunity set far broader and more unique than a single “emerging markets” banner. General weakness of this region hides India’s outperformance of U.S. equities since 2019, EMs’ approximate 60% contribution to global gross domestic product (based on purchasing power parity),³ and access to many of the world’s fastest‑growing and most demographically advantaged nations. We see considerable tailwinds for segments within emerging markets and believe longer‑term secular tailwinds are intersecting with shorter‑term catalysts. The potential peaking U.S. interest rates/dollar, an accelerating EM‑DM growth differential, and less entrenched inflation all combine to form a foundation we believe could support EM strength from here.

The impressive stimulus package announced in China could add to that momentum, but more detail and follow‑through are required to assess its impact on a struggling economy. And while tariffs are a new negative headline, their size and design are still unknown and may be targeted versus a “one size fits all.” Besides, our EM optimism extends beyond China with good opportunities in emerging Asia, with Vietnam, Indonesia, and the Philippines being particularly attractive due to their demographic advantages and expected recovery from recent cyclical weakness. India remains a good investment option, but higher valuations require prudence and careful management.

Although they may have become a forgotten asset class for some, we believe EMs remain relevant. While stock picking is key, we are encouraged that the market’s recent broadening has included strength within EMs and believe it can offer differentiated growth and diversification benefits from here.

Broadening of market will allow stock selection to matter again

The broadening of the market’s opportunity beyond the Mag 7 is a favorable development for active investing. Opportunities are presenting themselves across regions and sectors, in contrast to a market we would characterize as being driven by two themes up until recently: artificial intelligence and health care innovation (GLP‑1 incretins). And with a U.S. economy poised for an immaculate soft landing, falling global interest rates, and stimulus measures from China, the investment landscape has shown an improvement.

"The broadening of the market’s opportunity beyond the Mag 7 is a favorable development for active investing."

As we move into 2025, although geopolitical and macroeconomic factors will remain a feature for markets in the near term, careful stock selection can help to mitigate idiosyncratic risks. Long term, however, stock prices are ultimately driven by fundamental earnings power and cash flow generation. We believe diversified stock picking, careful risk management, and a focus on fundamentals will be the best way to navigate through what is likely to remain a complex market environment.