The past two years have been characterised by fortified resilience in equity markets, especially with the so-called Magnificent Seven (Mag 7) stocks leading gains. The seven stocks are: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. Alphabet is the parent company of Google while Meta owns Facebook, WhatsApp and Instagram.
These tech stocks were beneficiaries of the booming artificial intelligence (AI) industry evident in the impressive 25% gain on the S&P 500 in 2024. Rarely has the market witnessed such great equity gains and 2025 is likely to bring about sustained gains albeit with less vigour as seen in the unwavering willingness of the US equity market to pump in more capital into the AI sector.
However, the dominating headlines of 2025 thus far have been US President Donald Trump’s aggressive and unpredictable tariff policies and the emergence of China’s AI model DeepSeek which have thrown the stock market into a world of uncertainty.
The immediate market reaction to DeepSeek was a US$1 trillion ($1.35 trillion) hit in market capitalisation. On top of that, the day Trump announced his tariffs on Feb 3, the Nasdaq futures plunged 2.7%, subsequently bouncing back by 2.15% since then as of Feb 10 post-trading hours.
“As we look ahead, the investment environment is likely to become more nuanced and volatile”, say David Philpotts, Schroders’ head of QEP strategy and equity solutions, QEP Investment Team; and Lukas Kamblevicius, co-head of QEP investment team.
With this in mind, the pair believes that “combining a quantitative and fundamental approach to investing in equity markets” is a good approach towards facing the markets of today. In their report dated Feb 7, the pair have listed out several stock market themes for 2025 and beyond.
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Expect volatility
Philpotts and Kamblevicius are advising investors to not be too “sanguine” about the boom in equity market returns, as threats of a global trade war loom and bond vigilantes return. Rotations in market leadership away from dominant themes in the past two years are also pressing issues from a bottom-up perspective.
Market concentration to stay
The global markets have been dominated by US equities, at about 50% of global share value according to Goldman Sachs. While this results in overly concentrated portfolios, the same is not necessarily true for indices and mispricing should matter more for investors rather than concentration.
The pair do not observe much evidence of a bubble in the big index stocks and believe that, even with difficulty for big stocks to maintain outperformance, US market concentration will stay for the time being.
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Testing times for AI enthusiasts
AI has shown great promise in producing great productivity and efficiency gains which has resulted in large quantities of capex, with estimates of capex in the coming years to hit US$1 trillion ($1.35 trillion).
However, AI is capital intensive, which brings doubts if the associated costs of investing in AI decline fast enough to make the productivity gains sufficiently cost-effective.
To which, the pair suspect that the market may be “close to the peak” of inflated expectations and that more concrete case studies of productivity-enhancing AI applications are necessary before estimates of its beneficial impact become more certain.
Pay-off from global diversification attractive
Strong productivity has been the name of the game driving American exceptionalism, with strong evidence to support sustained growth of productivity to come. Expensive valuations of the US equity market could reverse US dominance but extraordinary earnings appear to justify these high valuations.
However, decreasing room for growth has made prospective opportunities in markets like Japan more attractive to the investor, prompting regional diversification.
That said, the pair still like the US from a “bottom-up perspective” but see increasing opportunities from Japan and continental Europe.
King dollar in the balance
The US dollar once again will benefit from the Fed's inability to ease rates significantly and most analysts believe that Trump’s policies will continue driving up the US dollar, despite calling otherwise. There is perhaps more clarity outlining the headwinds facing the US dollar, such as possible tax cuts eroding the confidence in the country’s fiscal position.
Progress on sustainability
Big stocks once again hampered the performance of environmental, social and governance (ESG) portfolios. However, there is progress in corporations setting climate targets and clients are developing goals surrounding sustainable solutions instead of focusing on quantitative target setting. “We don’t believe that there needs to be a trade-off between sustainability and longer-term investment performance, but implementation choices are critical,” states the pair.
High interest rates and volatility to stay
High starting current valuations in the US market will most likely cause lower investment returns especially in the equity market. It seems that a return to higher post-Covid-19 interest rates is probable which will challenge poorly-managed companies and necessitate strategic adjustment by investors.
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Cautious optimism heading forward
The key investment implication is not dissimilar to last year in that equity investors have had a relatively easy ride of late but there are plenty of sources of potential risks to navigate ahead.
While valuations are not extreme, they leave little room for disappointment. Philpotts and Kamblevicius would suggest that there is scope for the market to broaden without necessitating a reversal in the recent dominance of large-cap growth style in the US.
They do suspect, however, that there will be greater interest in diversification, particularly stocks with more defensive properties. Remaining diversified across the quality spectrum will be key.
Finally, the pair advised investors to always resist making sweeping assertions but flag the strong probability of higher volatility.
Unloved areas to watch:
1. Value investing
Philpotts and Kamblevicius have highlighted that there are several neglected areas in the market to take into consideration.
Value investing faced a tough 2024 due to the dominance of big US stocks. However, cheaper stocks do not appear to be fundamentally challenged and focusing on the “sweet spot” of identifying affordable quality is important too moving forward.
“A reversion to their longer-run discount to the market would imply strong gains for value, particularly if this is overlaid with a dual focus on both value and quality,” says the pair.
“We will continue to focus on the long-run sweet spot of identifying affordable quality on a bottom-up basis,” they add, noting that doing so will offer them the advantage of diversification benefits if the market tips back into risk aversion mode, due to the more defensive nature of quality.
2. Small-cap stocks, which may have diamonds in the rough
Small-cap stocks have had little evidence in recent times that they are fundamentally attractive. Moreover, there’s been a rising proportion of “at risk” small US stocks and high economic uncertainties facing small European stocks.
However, do not neglect the “diamonds in the rough” as seen among small Japanese stocks which exhibit less leverage and a more stable economic outlook especially as Japan starts heading out of a long period of deflation.
3. Emerging markets
Emerging markets (EMs) are still lagging behind the MSCI World Index in 2024, with the MSCI Emerging Market Performing Index underperforming by 11.2% during the year.
“The key issues for EM investors to navigate are the extent of Trump’s tariffs, how the Federal Reserve reacts to incoming inflation data and China’s success in boosting domestic consumption”, states the pair.
Stability and strength in governance to achieve economic growth are important to any emerging market. Philpotts and Kamblevicius recommend adopting a risk-management-based mindset especially when good stock opportunities present themselves.
