Equity Market Outlook 2025 Searching for Pockets of Opportunity

US equities continue to retain favored status heading into 2025, although a soft landing may present investors with potential to broaden portfolios into small caps and emerging markets. Pockets of opportunity also exist elsewhere, but a selective approach is recommended.

To expand on the famous quote by the investor Benjamin Graham,¹ in the short run, the stock market acts like a voting machine, driven by sentiment and flows, while over the long run, it functions as a weighing machine with fundamentals and economic realities shaping market direction. These dynamics are now particularly relevant, with global equity markets navigating short-term uncertainties — such as the trajectory of policy rates and election outcomes — alongside deeper structural shifts like demographics, geoeconomic fragmentation, and the rise of transformative technologies. The impact of these forces on valuations and earnings shapes our view of equity return potential across geographies and sectors.

US Equities: Momentum Maintained

We anticipate that US Large Cap equity can maintain its structural advantage over developed markets (DM) equities. US companies continue to deliver on what the market values most — profitability and earnings growth, driven mainly by the technology sector and the so-called Magnificent 7, in particular. Consensus earnings growth of 15% is estimated for 2025, and we expect the positive momentum to continue against the backdrop of an economic soft landing.

Furthermore, these earnings appear resilient to monetary policy moves, and could further benefit from political tailwinds. Net interest payments as a percentage of profits are at historical lows, preserving the profitability advantage of the United States, and the new Trump administration and Republican-led Congress could extend the Tax Cuts and Jobs Act and adopt a more favorable regulatory stance toward big tech.

This would support large caps but could also help broaden performance into more cyclical sectors, perhaps amid a renewed focus on traditional energy production or deregulation of financials, and help lift earnings growth in smaller names (Figure 1). Confidence levels among US small businesses appear in a holding pattern — sentiment has moved sideways on hopes that risks abate as post-election clarity emerges on areas of government policy and the path of monetary policy. Should both prove favorable, and labor markets remain resilient, a bounce back in small caps could be on the horizon given relatively attractive valuations and the potential for higher earnings growth.

Valuations are often cited as a risk to the market’s progress, while the ongoing assessment of artificial intelligence (AI) and related themes present questions about momentum and monetization of these high-profile technology advances. However, the S&P 500’s current price/earnings-to-growth (PEG) ratio is 1.5x, which is below the 10-year average.² Meanwhile, the Information Technology sector PEG of 1.7x is only slightly above the 10-year average, showing the market isn’t that expensive relative to its growth potential. However, any misstep in earnings, particularly from the top names, would be cause for concern.

European Equities: Consumer Remains a Drag

On the surface, the European economy appears to have a lot going for it: Household savings rates are high, wage growth robust, unemployment low, and the effects of disinflation positive. However, the economy is still lagging due to a combination of weak consumption, poor domestic demand, and low fixed investment driven by a dearth of confidence in the region’s growth prospects. Against this backdrop, earnings guidance has unsurprisingly been revised lower.

China’s woes provide another headwind as revitalizing Chinese domestic demand will take time, and even longer to transfer to the eurozone. This drag is particularly keenly felt in Germany, for whom China is a major trading partner, and this is now compounded by fresh political uncertainty in Berlin.

Even so, at roughly 10% earnings growth for 2025 and at a forward price/earnings (PE) multiple of 14x — which is below the five-year average — there is opportunity to be found in Europe. For the eurozone, these opportunities may be found in global sectors such as Energy (attractively priced versus US counterparts), Health Care (Europe is home to leading global companies), and Industrials (leaders in clean energy infrastructure), that are less exposed to consumer-related weakness in their domestic markets.

Japanese Equities: Wariness Warranted

Notwithstanding recent success for Japan’s stock market, we anticipate a move sideways given the potential for volatility as the market digests new unknowns. The strong tailwind from inflation and revitalized growth prospects that this year propelled Japan’s stock market through its 1989 peak may be fading. Instead, hawkish monetary policy and political uncertainty present new risks and could offset the positives that have largely been priced in. The expectation of higher bond yields and declining yen repatriation are also likely to put downward pressure on the equity risk premium, creating a shift in investor risk appetite to favor fixed income over equities, especially amidst Japan’s political transition. Although Japanese equities have typically experienced relief rallies following general elections over the past decade, this time might differ should the prime minister’s post mimic the revolving door of recent predecessors.

Chinese Equities: Stimulus Is a Short-term Fix

While providing a boost for the country’s stock market, China’s recently announced stimulus provides only a short-term fix. It does little to address structural problems, causing us to doubt the stamina of the rally. China’s chronically high debt levels, a housing overhang where consumers are 70% levered to the property market, and worsening demographics create structural issues that hurt consumer demand and sentiment. The People’s Bank of China (PBoC) plan to recapitalize banks may not yield the long-term results it hopes for as the measures to date simply aren’t sufficient to fix the underlying issue — a lack of demand as reflected by drying-up foreign direct investment (Figure 2), weak domestic consumption, and below-target economic growth. Until these core issues are addressed, we expect China to struggle in sustaining higher growth and strong equity market performance.  

Emerging Market Equities: Improving Prospects

Emerging markets look promising given economic growth potential, strong earnings growth estimates, and easing inflationary pressures. Falling interest rates, particularly in the US, could provide additional tailwinds, although this does not always pan out as expected.

Geopolitical risks will likely keep exuberance muted and the US dollar resilient, while economic fragmentation creates drag. Furthermore, despite attractive valuations, most emerging markets lack the high return on equity (ROE) and margins to excite investors. However, idiosyncratic country risks present opportunities for selective investors in broader emerging markets, which includes profitable stocks with higher growth potential, particularly in smaller names, as investors rebuild an underweight position back to neutral.