Perspectives

Global equity markets ended the year with a modestly positive return, but in the fourth quarter gave back much of the prior quarter’s gains. The large cap, MSCI World ex-USA Index fell -7.4%, which was slightly better than small cap performance with the MSCI World ex USA Small Cap Index down -7.9%. As has been the case for some time, local returns were much better, but US Dollar Index strength (+7.7% in the quarter) was a stiff headwind for US investors in non-US markets. For the full year, the MSCI World ex USA Small Cap eked out a positive USD return of just 2.8%.

The same returns for a euro (+9.9%) or yen (+14.8%) investor would have been much more attractive and in-line with what we see as the fundamental returns of the underlying businesses. This is not to make excuses, but to highlight a key point to US-based investors; returns are often made up of two key components, currency and price. In the last 15 or so years, the US market has delivered outsized returns on both. Further, within the US markets, large cap stocks have significantly outperformed small caps. So, the largest market in the world has been the best performing with a strong currency. This outperformance attracts flows, which in turn, boosts the performance in a classic positive feedback effect.

Given that a meaningful portion of US performance during this period has come from multiple expansion, while earnings have been boosted by historically high¹ profit margins, it is time for investors to revisit geographic country weights. Investors who have been exposed to US assets for the last decade have seen an extraordinary run in appreciation, especially compared to other countries. They have in fact “won” and should consider taking some of their winnings (e.g., large, expensive stocks) and use the strong currency to buy much cheaper, small cap stocks in non-USD denominated markets. No one can predict forward returns, but by most metrics the gap between the two makes a similar outperformance of US assets going forward unlikely.²

At this time last year, we made the claim that 2024 would be a year of elections. It did not disappoint. 2025 will be the year where policies and changes to policies from those elections are likely to matter. Rather than forecast, we will speculate on some areas we think will change. China-US relations will be critical, and while our base case is for higher tariffs and potential renminbi devaluation, it is possible that instead we will get an economic détente with a dramatic shift in Chinese policy away from investment and towards consumption.³ In the Middle East the humbling of Iran and return of the Trump administration may open the door to a completion of the Abraham accords, ushering in a period of stability and prosperity to a long-suffering region.

Within the EU we see the changes as less hopeful as this year’s elections have not resolved underlying issues. France remains a fulcrum country with potentially major changes in its politics driving market concerns over its finances. However, it probably does not hurt that the head of the European Central Bank is likely to have political ambitions, which would be helped by some French bond buying. In Germany, almost any policy change would be positive for markets. Post February elections we may see some reform of the debt break, which has hamstrung the German government’s ability to boost public investment at a time when it sorely needs it. Japan remains a potential powerhouse if only they are able shake off their post-bubble lassitude and find a bit of that Shōwa-era spirit.

Finally, we remain upbeat about many of the smaller markets on the periphery, which are composed of interesting investment opportunities outside the spotlight of major markets.

With contributions from members of our Global Equities Team

¹ And traditionally thought of as mean reverting.
² The same argument could have been made almost any time since 2018, and while we did not make that case as strongly at the time, there is nothing to say we will not be making it again in future years.
³ This is what is required to fix Chinese economic malaise. They know it too.