Investor Outlook: Beyond American shores – why diversification is your strongest ally

Moreover, widespread investor positioning in the Magnificent Seven means that during market stress or heightened volatility, these stocks often become prime candidates for liquidations. Investors typically sell what they can, rather than what they prefer, exacerbating volatility in these heavily owned mega-cap names. Consequently, portfolios with significant exposure to these stocks may experience amplified fluctuations during turbulent market conditions.

Given the sheer scale of the US market relative to other global markets, even modest shifts of investor capital away from US equities toward undervalued international markets could significantly boost valuations in these smaller markets. Investors diversifying now may thus position themselves strategically ahead of these potentially powerful trends.

Valuation, policy, and currency headwinds facing US equities

Beyond concentration risks, US equities remain historically expensive, trading at approximately 22 times forward earnings—well above historical averages. Actually, it’s as high as the 93^rd percentile over the last 20 years, meaning that the US market has only been this pricy 7% of the times.

Furthermore, America's increasingly volatile policy environment, marked by ongoing trade conflicts and potential regulatory shifts, further erodes the market's attractiveness to international investors.

Compounding this challenge for European investors specifically is a weakening US dollar. We expect USD weakness to continue throughout 2025, which directly reduces returns on US holdings for European investors, adding yet another layer of complexity and risk.

Conversely, a weaker USD represents a meaningful positive tailwind for emerging market equities. Historically, emerging market stocks benefit from a depreciating dollar, as competitiveness improves, foreign investment inflows rise, and debt burdens ease. With continued USD weakness expected, alongside improving economic fundamentals, emerging market equities are particularly attractive today.

The BABA trade: Buy Anything But America

Overweight Europe: historic fiscal transformation—a lasting catalyst

Europe is undergoing its most expansive fiscal stimulus in decades, spearheaded by Germany’s ambitious EUR 500 billion infrastructure and modernisation initiative. This multi-year structural investment isn't yet fully priced into markets, providing a compelling window of opportunity.

European equities have notably outperformed US markets this year, prompting investor questions about how much of this positive stimulus is already reflected in prices. While some optimism is certainly priced in, the scale and multi-year nature of these initiatives suggest substantial room remains for further appreciation.

In our previous outlook, we highlighted the "European Independence" theme, which continues to deliver meaningful value. In Q2, this theme significantly outperformed the broader European market, with our thematic shortlist returning 9%, compared to 4.1% for the Stoxx 600. This result underscores the continued relevance and potential of investing in European resilience and strategic autonomy.

Companies in infrastructure, industrial equipment, construction, renewable energy, and defence continue to offer robust investment opportunities, with especially attractive potential identified in Spain, Germany, and Italy. Germany’s ambitious infrastructure spending strongly benefits its industrial and automation leaders, while Spain’s dynamic economic momentum and thriving banking and renewable energy sectors present compelling entry points. Italy offers attractive valuations in financials, utilities, and construction sectors, supported by improving economic fundamentals and targeted fiscal investment.

Sector-wise, we remain particularly optimistic about financials, especially banks, due to attractive valuations, robust earnings resilience, and stable dividend yields. Green energy and utilities offer structural growth, driven by Europe’s accelerated energy transition. Industrials and infrastructure sectors will significantly benefit from ongoing fiscal stimulus, boosting both earnings visibility and growth prospects.

Key risks to watch: Despite this optimism, investors should remain mindful of Europe's potential challenges, such as political fragmentation within the EU, slower-than-expected implementation of stimulus projects, and prolonged inflationary pressures potentially impacting corporate profit margins.

Overweight Japan: quietly rewriting its corporate narrative

Japan offers another powerful diversification story. Historically known for weak corporate governance and limited shareholder rewards, Japan is quietly undergoing a meaningful corporate governance revolution. Companies are increasingly focused on profitability, higher dividends, and improved shareholder returns.

Japanese equities remain attractively valued around 15 times forward earnings, supported by continued accommodative monetary policy from the Bank of Japan. These reforms and appealing fundamentals make Japanese stocks an excellent global diversification opportunity. However, investors may want to focus particularly on domestically oriented companies and select defence sector names, as a stronger yen could pose challenges for traditional export-driven businesses.

Key risks to watch: Investors should monitor Japan’s exposure to global economic slowdowns, sensitivity to yen strength potentially impacting exports, and the risk that corporate governance reforms might stall or fail to meet investor expectations.

Overweight emerging markets: thriving amid USD weakness

Several emerging markets offer substantial growth potential at attractive valuations—around 13 times forward earnings. Countries such as India, Brazil, Indonesia, and Mexico have robust domestic economies, improving earnings momentum, and increasingly stable currencies.

The anticipated weaker USD further enhances these markets' appeal, improving currency-adjusted returns for European investors and underscoring the case for geographic diversification.

Key risks to watch: Emerging markets remain sensitive to shifts in global investor sentiment, political instability, and policy changes. Rising geopolitical tensions and commodity price volatility also pose potential threats to sustained growth in these economies.

China: a tactical, selective approach

China represents a more cautious story. With historically low valuations (approximately 10 times forward earnings), there is undoubtedly potential upside. However, ongoing policy uncertainty, geopolitical tensions, and structural challenges mean investors should approach China tactically and selectively, mindful of volatility. Investors should particularly focus on sectors explicitly supported by Chinese policy, such as green energy, electric vehicles, advanced manufacturing, and digital infrastructure and tech, and companies with strong domestic market positions.

Key risks to watch: Investors should closely monitor regulatory risks, ongoing trade tensions with the US, property sector challenges, and consumer confidence levels, as these factors may significantly influence China’s economic trajectory and market sentiment.

Two global themes: AI's second wave and structural defence growth

Beyond geography, two thematic investment opportunities deserve attention:

Artificial intelligence's initial boom centred around expensive US hardware stocks. However, AI's next growth phase will significantly broaden, benefiting global companies successfully leveraging AI across enterprise software, healthcare, industrial automation, and financial services. Europe and Japan offer attractively valued entry points into this productivity-driven wave of AI innovation.

Persistent geopolitical tensions continue to underpin robust global defence spending. Defence stocks, especially in Europe, have risen sharply, driven by increased government budgets and strategic autonomy initiatives. While secure contracts and political commitment provide foundational support, the rapid increase in valuations means investors must exercise caution.

Current valuations, in many cases, reflect optimistic long-term growth scenarios, raising questions about how much further upside remains without additional positive catalysts. Investors should carefully monitor earnings sustainability, policy execution, and broader economic conditions, recognising that elevated valuations could moderate future returns. Cybersecurity, now essential to national and corporate security, continues to offer a relatively less stretched, complementary structural investment opportunity.

Diversification is your strongest ally

Like championship football teams, successful investment portfolios depend on strategic balance and diversification—not just a handful of star players. Today's extreme concentration in US markets underscores why this timeless investment principle has never been more relevant. By diversifying thoughtfully into Europe, Japan, and emerging markets, you strategically position your portfolio to benefit from shifting global investment flows, structural opportunities, and beneficial currency dynamics.