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2025 - A Pivotal Year
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Global Multi-Asset Macro Musings
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März 05, 2025
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2025 - A Pivotal Year
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März 05, 2025
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2025 - A Pivotal Year
2025 - A Pivotal Year |
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Bottom Line
Extrapolation of fundamental trends into perpetuity has resulted in extreme overvaluation, overoptimism and overownership of many assets, most particularly U.S. assets, including the U.S. Dollar, U.S. stocks as well as momentum stocks, fast-growing stocks, AI-plays and highly speculative assets. Investors should position for a reversal of many of these trends by owning non-U.S. stocks denominated in non-US currencies (including Emerging Markets) as well as Value and small cap stocks in the U.S. and abroad.
Many market trends have persisted for so long that investors are extrapolating them into perpetuity, giving rise to extreme prices and valuations. We expect 2025 to be a pivotal year where many trends reverse, violently for some, slowly for others.
The drivers of the most notable market extremes are: 1) U.S. exceptionalism, as reflected in U.S. stock prices relative to non-U.S. stocks and the U.S. Dollar, and 2) Enthusiasm for AI, as reflected in the pricing of mega cap, growth and quality stocks relative to small cap and value stocks.
Extremes Driven by U.S. Exceptionalism
U.S. equities have outperformed global equities by 250% since late-2009 and, not only are they now the most expensive ever versus the rest of the world, but they are also overowned and vulnerable to a reversal.
- U.S. stocks trade at a never-before-seen 70% premium to the rest of the world (see Chart 1 below). The U.S. now represents nearly 70% of global market capitalization and is most investors’ preferred market for 2025 outperformance. As one strategist put it, “the more it outperforms, the more investors expect it to keep outperforming.” U.S. exceptionalism is accepted as the new reality. This is reminiscent of 2010, when it was believed that China’s economy would overtake the U.S.’ by 2020, and in 1989, when it was believed that Japan would take over the world.
- Potential catalysts we are watching for the tide to turn on U.S. dominance (we lean towards the first three):
- U.S. growth disappoints: Trump’s policies turn out to be less pro-growth than expected. The economic hit from tariffs (both actual and uncertainty related to them), immigration, modest fiscal tightening to pay for the Trump tax cuts extension,1 and DOGE cuts to government spending and jobs could detract 75-100bps (basis points) from GDP growth over 12 months, causing the first U.S. growth disappointment in years.
- The rest of world finally recovers: falling global inflation (near 2% from peaks of 8%) and policy rate cuts prompt households to start spending again (for some countries, like the Eurozone, from record savings rates as high as 15%), and stimulate business activity as bank lending improves. Data shows this may already be beginning. EMU and Japan GDP growth reaching 1.5% and EM ex-China growth remaining stable at 3.5% would be sufficient for 5% earnings outperformance and a 10%+ multiple re-rating. In addition, China could surprise by finally comprehensively addressing its balance sheet recession.
- The AI investment boom reverses (see below): the virtuous cycle between AI enthusiasm, higher U.S. stock prices, increased household wealth, and increased consumption reverses, turns into a negative feedback loop (lower stock prices, lower wealth, lower consumption).
- The U.S. economy overheats, requiring Fed hikes in early 2026 – which the market would start pricing in advance. In past soft landings, the Fed hiked within 20 months of its first cut (i.e. April 2026). This would likely bring long yields above 5% and TIPS above 2.5%.
- U.S. bond vigilantes awaken from their long slumber and revolt against funding 6.5% deficits as far as the eye can see at 4.0-4.5% rates. Yields could be driven up to 6-7%, forcing fiscal austerity.
- U.S. growth disappoints: Trump’s policies turn out to be less pro-growth than expected. The economic hit from tariffs (both actual and uncertainty related to them), immigration, modest fiscal tightening to pay for the Trump tax cuts extension,1 and DOGE cuts to government spending and jobs could detract 75-100bps (basis points) from GDP growth over 12 months, causing the first U.S. growth disappointment in years.
- We see specific opportunities for:
- Eurozone domestically-oriented stocks, which trade at a more than a 40% discount to U.S. domestic stocks2 with equivalent growth prospects and double the cash return to shareholders.
- Japan domestically-oriented stocks, and Emerging Market stocks – which are even cheaper than European stocks.
- Eurozone domestically-oriented stocks, which trade at a more than a 40% discount to U.S. domestic stocks2 with equivalent growth prospects and double the cash return to shareholders.
The U.S. Dollar, up nearly 50% since 2011, is overbought and the most expensive it has been since 1985 (see Chart 2 below).
- Potential catalysts for reversal include:
- The U.S. Dollar loses fundamental support as U.S. exceptionalism is called into question (as discussed above).
- The U.S. Dollar’s yield advantage is past its peak, while tariffs will likely end up being buy-the-rumor-sell-the-news events.
- We see specific opportunities for:
- The Euro and Yen, which are at record cheap levels, and could rally 10% or more. Investor pessimism toward the Euro has been extreme, with recent calls for parity despite cheapness.
- EM currencies, where investors are currently extremely pessimistic while EM fundamentals are reasonably solid with decent growth, some disinflation and no external imbalances (despite some fiscal issues in some countries).
Extremes Driven by Enthusiasm for AI
Growth and Quality stocks at extremes: after 15 years outperformance, growth and quality stocks are overvalued, over-owned, and massively overinvested.
- Near record valuations and crowded positioning leave these stocks vulnerable to disappointment and outflows. The “growthiest” stocks and the highest quality stocks3 are trading at valuations in the top one percentile of the past thirty years. Concentration, a good indication of crowding, is the highest it has ever been: the largest 10% stocks in the S&P 500 account for more than half of total U.S. equity market cap. This is even higher than during the Nifty Fifty Bubble of 1972-73 and the 1990s Dot Com Bubble (see Chart 5 below).
- The tech sector’s capex boom is the largest in decades. In many cases, there is no clear path to return on investment.
- Myth of the moat: U.S. hyperscalers have plowed hundreds of billions of dollars along with VCs into building AI data centers and developing Large Language Models (LLM). Hyperscalers expect cloud revenue growth to expand, with the best AI models reaping the majority of the rewards. However, DeepSeek’s R1 open-source model release called into question the perceived moat of industry AI leaders and challenged assumptions about how much data center capacity would ultimately be required. If AI models can be replicated and distributed for free, with lower hardware requirements, hyperscalers and AI developers may never generate an attractive ROI to justify current capex spend.
- The four U.S. hyperscalers are on track to increase capex by more than 30% in 2025 (to nearly $325bn). This represents over 20% of sales, double the percentage of a decade ago. Already, capex is outpacing very strong operating cashflows: hyperscaler free cashflows contracted year-over-year in 2H24 and will likely drop 15-20% in 2025 (see Chart 4 below). In recent months, their forward earnings and free cash flow estimates have started lagging the rest of the market.
- Myth of the moat: U.S. hyperscalers have plowed hundreds of billions of dollars along with VCs into building AI data centers and developing Large Language Models (LLM). Hyperscalers expect cloud revenue growth to expand, with the best AI models reaping the majority of the rewards. However, DeepSeek’s R1 open-source model release called into question the perceived moat of industry AI leaders and challenged assumptions about how much data center capacity would ultimately be required. If AI models can be replicated and distributed for free, with lower hardware requirements, hyperscalers and AI developers may never generate an attractive ROI to justify current capex spend.
- We believe Value stocks offer the greatest opportunity, given how expensive and overowned Growth and Quality stocks are and the likelihood of a reversal (see Chart 3 below).
- U.S. Value stocks match historical extreme levels of cheapness4, at 10x forward EPS vs. 30x for expensive stocks. Historically, at similar levels of cheapness (December 2000, November 2008), Value stocks have outperformed expensive stocks by 200% and nearly 120%, respectively, over the subsequent eight years.
- In Japan, Europe and Emerging Markets, Value stocks have outperformed expensive ones since the fall of 2020 (despite some wobbles in 2024) but continue to trade at attractive discounts, especially in Europe and some Emerging Markets.
U.S. large cap stocks have outperformed small caps by 62% over the past 8+ years.
- Small caps are undervalued, unloved and underowned.
- The entire Russell 2000 Index’s market cap ($3.2trn) is less than the market cap of AAPL ($3.7trn) or NVDA ($3.4trn).
- Small caps are trading at a 25% discount to large caps on forward P/E (16.7x for S&P 600 vs. 22.2x for S&P 500). A similar discount in 2001 preceded 87% outperformance over the subsequent decade.
- Potential catalysts for outperformance:
- We expect small cap earnings to outpace large cap by 5% (15%+ vs 10%+) over the next two years, a sharp reversal from two years of 15%+ p.a. underperformance, but more in line with small caps’ traditional superior earnings growth. Small cap stocks are more cyclical than large caps with a higher weighting of industrials and financials, and less tech. The manufacturing cycle, in the doldrums in the past couple of years, looks to be improving as tech starts to lose steam (see above).
- Small caps are more levered and have been hurt by rising rates. At this point, most cuts have already been priced out, though rate hikes would be a risk to small caps.
Speculative bubbles: we see a high level of speculative enthusiasm in markets today.
- The market cap of the entire crypto space hit new highs in December at nearly $4trn (with Bitcoin at $2.0trn and altcoins another $1.9trn). Unsatisfied with the low risk of bitcoin (1-year vol 41%), investors were recently buying bitcoin at a 200% premium through Microstrategy stock (1-year vol 108%), as well as a 2x levered ETF on Microstrategy stock ( 1-year vol 200%).
- Retail investors have plowed more money into stock mutual funds and ETFs than ever before (roughly $20bn per week since the election), having been rewarded by dip-buying for the past dozen years.
- The 2024 momentum run is persisting in 2025 with high momentum stocks outperforming low momentum by 39% over the past fourteen months. This is the third biggest momentum run of the past thirty years. All previous top decile momentum runs nearly fully reversed in the subsequent year.
Speculative excesses always reverse, but the catalyst is often not apparent until well after the fact – this is unlikely to be different this time.
Bottom Line: extrapolation of fundamental trends into perpetuity has resulted in extreme overvaluation, overoptimism and overownership of many assets, most particularly US assets, including the U.S. Dollar, U.S. stocks as well as momentum stocks, fast-growing stocks, AI-plays and highly speculative assets. Investors should position for a reversal of many of these trends by owning non-U.S. stocks denominated in non-U.S. currencies (including Emerging Markets) as well as Value and small cap stocks in the U.S. and abroad.
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Head of Global Multi-Asset Team
Global Multi-Asset Team
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