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Market broadening and a new chapter for emerging markets
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. 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, while innovations in health care, and specifically GLP‑1s, have also seen select companies benefit. These powerful investment trends remain, but peaking earnings growth for some of these companies point to change and lessen their appeal for investors. Although still in its infancy, the broadening of equity returns beyond the magnificent seven looks set to continue into 2025.
Scott Berg, portfolio manager, global equities for T. Rowe Price.
To be clear, however, these are high‑quality companies that have delivered strong profitability and free cash flow, and although the infrastructure and investment cycle for AI may be peaking, we 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.
Don’t overlook emerging markets
Emerging markets - which were prominent in many portfolios throughout the 1990s and during the BRICS era - have been deeply out of favour 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 per cent discount to their developed market (DM) peers[1], according to the financial data and analytics provider FactSet, 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 US 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 US administration.
But China woes and US dollar strength have been clouds hanging over an opportunity set far broader and more unique than a single emerging markets (EM) banner. General weakness of this region hides India’s outperformance of US equities since 2019, EMs’ approximate 60 per cent contribution to global gross domestic product (based on purchasing power parity)[2], according to World Economics 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 US 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 potential US tariffs are a new negative headline, their size and design are still unknown and may be targeted versus a “one size fits all”. But 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.
Beyond Mag 7
The broadening of the market’s opportunity beyond the Mag 7 is a favourable development for active investing. Opportunities are presenting themselves across regions and sectors. And with the US economy poised for an immaculate soft landing, falling global interest rates, and stimulus measures from China, the investment landscape has shown an improvement.
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. Therefore, 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.
[1] Source: Financial data and analytics provider FactSet. Copyright 2024 FactSet. All Rights Reserved. As of September 30, 2024.
[2] Source: World Economics.
Scott Berg is portfolio manager, global equities for T. Rowe Price.
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