The overwhelming factors behind equity market strength this year have been earnings delivery (particularly in the US) combined with investor optimism that this can extend into 2025. “For the time being global equities, despite elevated valuations, can continue to do quite well given a relatively favourable economic backdrop”, says Alex Tedder, Co-Head of Equities at Schroders. “Looking further ahead, however, the outlook is rather less certain.”

In the first half of the year, six stocks (Meta, Alphabet, Microsoft, Nvidia, Amazon, Apple), or the “Mega-Tech” stocks accounted for more than half the total return of the US equity market. Unsurprisingly these six are all linked to the theme of Artificial Intelligence (AI).

Shares in Nvidia (the leading producer of the chipsets powering AI) are up more than 600% since the launch of ChatGPT in November 2022. Investor exuberance was further buoyed by strong revenue and earnings growth across the board, pushing the concentration of the US equity market to record levels, as shown on the right of the chart.

“The outlook for these companies, and for the technology sector in general, remains generally positive,” says Alex Tedder. “The largest companies are not homogenous but do share one common denominator. They tend to have specific characteristics that allow them to dominate their respective industries and generate exceptional growth, margins and returns. Unless there is significant regulatory intervention to break these “franchises” they will likely remain extraordinarily profitable companies and important components of global portfolios.”

However, one growing issue for this group is the sheer volume of spending being directed toward AI. The three big providers of AI infrastructure, Microsoft, Alphabet-owned Google and Amazon, known as the “hyperscalers”, are investing gigantic sums in an AI “arms race”, and the rate of spend shows no sign of abating. “In part, this is because they can afford to invest huge sums, given rock solid balance sheets and strong cashflows,” says Alex Tedder. “But the forecast incremental sales from these investments – over the next two years at least – are actually quite modest. The market is just not sure that the monetisation of these investments will be positive for shareholders.”

This comes at a time when, for the largest technology companies at least, earnings growth is beginning to slow. If the pay-back period from AI proves to be very long, investors are right to be questioning the sustainability of technology dominance, at least for the most exposed companies such as Nvidia.

Equities are expensive, but elevated valuations can be sustained (for the time being)

One consequence of the ongoing bull market in equities is that they have become expensive. Using a range of different and commonly used valuation measures, and comparing them to their long-term (15-year) medians, the US appears extremely highly valued, and no other market can be described as cheap. Even unloved markets such as the UK and Japan are by no means bargain-basement.  Alex Tedder : “Against that backdrop, equity markets are quite vulnerable to some form of negative catalyst (for example, an external shock arising from conflict escalation).”

In reality however these valuations are likely to prove quite well supported in the short-term. From a macro-economic standpoint, global inflation remains on a downward trajectory, allowing central banks to embark on a relatively synchronised interest rate cutting cycle.

Historically, falling rates have nearly always supported equity markets. Given the current strength of the US economy, a recession looks unlikely and business confidence in some of the more rate sensitive parts of the global economy will likely strengthen.

From a bottom-up standpoint, the ongoing strength of the US economy and gradual stabilisation in the rest of the developed and developing world should provide scope for sales and profit growth in 2025.

Consensus earnings estimates over the next two years for the key global regions are strong: 8-12% average growth each year (source: LSEG Datastream, Schroders Strategic Research Unit, as at November 2024). Assuming no de-rating of equity markets, the return opportunities from global equities would be reasonable, if not spectacular.

Implicit in these numbers and linked to the earlier discussion around the Mega-Tech stocks is the idea of a “broadening out” in markets: that is to say, hitherto neglected areas such as smaller-capitalisation/sized companies, begin to benefit from positive fund flows. As the table below shows small- and mid-sized companies are cheap versus both large caps and against their own history.

Trump 2.0: a lot can happen

The recent election of Donald Trump for a second term as US president is likely to prove the wild card for investors in the medium-term. These are Schroders’ high-level views:

• “America First”: this policy is going to apply to a raft of different areas but in a nutshell means less globalisation, weaker alliances, and more uncertainty. Markets, for obvious reasons, don’t like uncertainty.
• Tariffs and personal taxes: if Trump proceeds with his planned and much vaunted policy of imposing 10% or 20% tariffs on ALL imports and 60% tariffs on imports from China the effects will be dramatic. A tariff is a direct and regressive tax on the US consumer. Trump may try to offset the impact through personal tax cuts (largely to the benefit of the top 1% of earners) but in any event the impact will be inflationary. The bond market is already taking note.

Alex Tedder : “Under Trump, the world will clearly be a different place. There will be material intended, but also many unintended, consequences from some of his policy initiatives. At the very least there is likely to be more volatility in markets as a result. Our endeavour in this environment remains the same as always: to look globally for the companies that have the greatest scope to surprise positively in terms of revenue, cashflow, and earnings. Share prices can deviate from the fundamentals at times (sometimes for far longer than expected), but in the end they always follow earnings. In a volatile and rapidly-changing world, the importance of investment discipline becomes even more pronounced. We are positioned for growth, but also prepared for volatility.”

Further reading

• Outlook 2025 for global and emerging market equities, by Alex Tedder, Co-Head of Equities, and Tom Wilson, Head of Emerging Market Equities, at Schroders
• Schroders’ Outlook 2025 website : with in-depth articles about the outlook for equities, fixed income and private markets.