For more than a decade, US equities led global markets. Since the end of 2024 they have not. They have returned around 30% in dollar terms, against more than 50% for global markets excluding the US. Three explanations are usually offered: the Administration’s economic policies, index concentration in a handful of mega caps, and the valuations attached to AI-exposed companies. Tested against the sector data, that account looks incomplete. Most of the gap came from two sectors, for quite different reasons, and the diversification investors thought they were buying was narrower than it appeared.
Where the underperformance came from
Every major regional block has outperformed the US over this period. Emerging markets and Canada, over 30% of the global ex-US index, delivered the strongest additional returns; Japan and Europe, more than half of that index, were comfortable outperformers. These are dollar returns, and dollar weakness since end-2024 puts ex-US local currency returns around 5% lower on average. Currency is part of the story, but far from all of it.
The sector data complicate the picture. The US outperformed in only two of the ten sectors, healthcare and communication services, which suggests broad-based strength elsewhere. But several of those differentials are small, and some occurred in small sectors. What matters is large differentials in large sectors, and on that measure the gap was delivered by financials and IT, whose combined weight is around 40%.
The re-rating of ex-US financials
Financials in every ex-US regional block, around 25% of that index, have outperformed their US counterparts. This is an archetypal value theme. Ex-US financials had traded on low ratings since the aftermath of the 2008 crash and have rebounded from them, with clear catalysts. Rate normalisation has supported earnings, and capital discipline is evident: European banks are likely to return around 10% of their market capitalisation to investors this year through dividends and buybacks. Momentum has done the rest.
Why US technology lagged a global boom
The second sector is IT, which at first sight is curious. IT accounts for around a third of US market capitalisation, well over twice its average weight elsewhere, and it has been by far the strongest performing global sector. The answer lies in industry structure. Outside the US, IT is largely semiconductor manufacture, concentrated in Korea and Taiwan; within the US the split between software, hardware and semiconductors is more even. Ex-US IT, with little software exposure, avoided the marked US software sell-off and held far more of the semiconductors that have led the sector since end-2024. It returned roughly twice its US equivalent.
Superficial diversification
There is a paradox here. Investors moved away from the US partly because of concerns about speculative influences in the AI theme. The positioning worked, but through exposure to aspects of that same theme which have been more volatile than the US version. Concentration has moved rather than disappeared: the top three companies in the emerging market index account for over 25% of its market capitalisation, against under 20% in the US.
The wider point is that geographic diversification delivers less when sectors are global rather than local. Emerging Asian technology is not a competitor producing similar products to US firms; it is part of a supply chain straddling developed and emerging markets, and it does not dance to a different tune. Some sectors remain predominantly local, real estate and parts of retail among them, but they are a diminishing share of the market. A large reallocation between regions can change a portfolio’s properties by much less than its size suggests.
Policy, timing and the limits of one story
Where does this leave the Administration’s policies? They clearly mattered in specific episodes, notably the tariffs of spring 2025, and dollar weakness, partly attributable to US macro policy, has contributed. Underperformance also began very close to the change of administration, which looks more than circumstantial. But those policies did not re-rate European banks or lift Korean and Taiwanese semiconductor manufacturers. The underperformance came in two waves: the tariffs, and the interaction of financials strength with the US software sell-off around the turn of the year. Recent months have recovered some of it, and year to date US and non-US performance is broadly flat. Contingent, industry-specific developments have driven relative performance, not a single dominant theme.
The wider backdrop
With the exception of China, recent economic releases have consistently beaten expectations, and there is little evidence of sharp downturns. Scope for further adverse shocks remains, but we are less concerned about major destabilisation of the global economy. If oil is the old economy’s negative and the AI capital spending boom the new economy’s positive, the latter is so far predominating, at least in the US.
Fixed income returns have been subdued this year. An index yield of around 5% remains attractive, real yields have risen at short maturities, and fixed income remains an effective hedge in a deflationary environment. Against that, upside risks to US rates persist: growth momentum is significant, unemployment is low, and there is less transparency over Fed policy under the new Chair. Corporate spreads remain tight, limiting the scope for returns.
Saranac positioning
We are sceptical that this cycle has delivered a widespread bubble in global equity markets, even if there are pockets of speculation within it. Its buoyancy is likely to extend into next year, although its ultimate scale remains uncertain, and markets continue to reward the perceived winners whilst vulnerable companies underperform. This is not a theme that can be avoided, and our portfolios have significant exposure to it, though less than conventional equity indices. We retain a significant allocation to fixed income, and look to hedge funds and structured products for diversification that geography alone no longer reliably provides.
Read the August Outlook here.
This commentary is intended for information purposes only. It does not constitute a personal recommendation, financial promotion, or regulated advice. Past performance is not a guide to future returns. All views are those of Saranac Partners and are subject to change.
