Global equity markets have largely rallied over the last two years, fuelled by falling interest rates, unexpectedly strong US growth and the advance of artificial intelligence and technical innovation. The pace of this momentum was unsustainable. Political shifts, unstable geopolitics, economic uncertainties and disruption have triggered episodes of uncertainty. Yet, volatility creates opportunity.
While much of the recent equity gains have been concentrated in US Technology and AI, prospects for growth are shifting across many sectors and regions. Combining diverse perspectives and deep research makes it possible to identify innovative companies that have staying power through the volatility. The key is to look to the growth leaders of tomorrow.
The valuation question
For over two years, equity markets have enjoyed a sustained rally. In 2024 alone, the MSCI World Index jumped 19.2%1. The bull market led to euphoria with some markets priced for perfection and some investors neglecting diversification.
The Magnificent 7 stocks drove the bulk of these gains on the back of enthusiasm around artificial intelligence. The significant growth of these mega-cap companies led to market concentration reaching historic levels – for example, in February 2025, the largest 10 stocks in the S&P 500 represented around 35% of the index’s market capitalisation2. This was higher than the levels reached during the dot.com boom in the late 1990s. Understandably it has raised concerns that a bursting of a bubble might be forthcoming.
The difference this time was that these inflated stock prices were supported by a parallel spike in earnings expectations, keeping valuation metrics in check. Back in 2000, the price/earnings (P/E) calculations for the biggest stocks reached 60, whereas in early 2025 the P/E of around 30 for the top companies was comparable to the wider market3. However, while valuations may have appeared sustainable, the market was of course not immune to the factors that can damage the prospects of future earnings.
Benign macroeconomic future?
At the start of 2025, the benign macroeconomic outlook didn’t appear to be a catalyst for near-term market volatility. The economic consensus pointed to a soft landing for the global economy: inflation was expected ro return to target, the major economies were set to grow at a reasonable pace, and central banks were due to embark on policy easing, albeit at different paces. Such a scenario was seen as positive for equities, which historically perform well against a backdrop of interest rate cuts.
Yet, risks were lurking offstage that completely reset the outlook. Late in the first quarter we saw three key factors lead to a 180-degree turn in the consensus outlook:
- Increasing worries about prospects for the US economy;
- A potentially historic change in Germany on fiscal policy and European funding;
- Hints of a more determined policy response from China.
Belief in American exceptionalism has been eroded with concern in markets about the impact on US growth of volatility in US government policy. Uncertainties around the on-again/off-again tariffs applicable to America’s major trading partners and allies were exacerbated by concern about the impact on US employment and consumer income of the ongoing public sector cuts.
While inflation is under control, it is far from tamed. Tariffs and a fall in unemployment could easily reignite these pressures. Growth outside the US could turn out to be better than very pessimistic forecasts, particularly in Europe where Germany – the biggest economy – finally appears to be confronting its cyclical and structural headwinds. The Chinese economy may be working through long-standing problems in the property market, further assuaged by sizeable government stimulus. Meanwhile the US economy – which has consistently outpaced other developed markets in recent years – may not be able to keep up its recent pace of growth as doubts arise among investors about the administration’s policy framework and decision making.
Until the first quarter of 2025, investors were focused on the growth potential while perhaps not sufficiently considering some of the risks. As we have seen, negative adjustments to the economic outlook and the prospect of central bank cuts can quickly unsettle investor sentiment. But, when volatility resurfaces, so do opportunities for experienced investors.
Diverse geographic shift
The rapidly shifting geopolitical landscape is complex. Notwithstanding tensions around Ukraine, Israel and Taiwan, a significant market focus for geopolitics now resides around the Trump administration and the broad contours of its objectives.
Initially, US equities performed well after the election, reflecting the assumed benefits of the administration’s policies on tax and deregulation. The America First agenda was expected to stimulate domestic demand through reshoring initiatives, tariffs and a stronger dollar. However, the whirlwind of policy announcements since President Trump’s inauguration has left investors grappling with the implications for financial markets and raised questions about America’s reliability as a trading partner. The consequence has been increased volatility and uncertainty about prospects for US stocks as doubts arise about US policy and decision making.
Against this backdrop, some investors have turned to European markets. Alongside uncertainty about the direction of travel in the US, and some cautionary reallocating of assets for diversification purposes, US policy has led to an abrupt change in the markets’ view about Europe. Investors now see signs of the potential for a dramatic economic policy shift. Triggered by America’s treatment of long-standing security alliances and the change in its Ukraine policy, Germany is suddenly contemplating a relaxation of its long-standing fiscal constraints. This could mean increased defence spending, larger infrastructure investments and greater regional funding. While by no means certain at this stage, if it comes to pass, a new dynamic for Europe with an increased focus on defence spending, and an improvement in trading conditions could be beneficial for businesses across the continent.
Resilient thematic drivers
In an environment of shifting conditions, we believe investors should rethink their equity exposure to perhaps focus on investment themes whose growth drivers exhibit resilience regardless of what is happening around the world.
Innovative technology continues to have the capability to completely disrupt existing business practices and supply chains. Despite the already huge gains recorded by technology companies, the broad applicability of artificial intelligence (AI) still looks set to drive innovation and creative destruction in the years ahead. AI adoption has the potential to boost earnings across a breadth of sectors, such as healthcare, education, logistics and mobility. However, fresh doubts about tech valuations and the dominance of the US for AI were sparked by the launch of the Chinese AI model DeepSeek and serve as a healthy reminder that technological development doesn’t advance in a straight line.
The ability to drive change through innovation doesn’t solely reside within the technology sector. The provision and distribution of healthcare services are being transformed by advances in robotic surgical techniques, novel drug delivery and gene-encoding discoveries. Alongside traditional infrastructure build-out, new solutions are also gaining traction – creaking water systems are being revitalised by smart irrigation systems, quality monitoring and the tracking of usage and leaks.
Small capitalisation companies can be a promising focal point for harnessing innovation opportunities, as many small-cap companies operate in niche markets. For example, the AI ‘arms race’ is not just boosting the revenues for the Magnificent 7 companies, but is also bolstering many lesser-known hardware, software, industrial, materials and even utility companies.
Importantly for investors, opportunities driven by innovation can be surprisingly diverse and resilient, spanning geographies, sectors and end markets.
Channelling opportunities in innovation
While the outlook for equities may be more positive, volatility is a consistent theme through global markets. Against this backdrop, opportunity will lie in identifying the companies that are driving growth and have the ability to thrive no matter the market challenges.
At BNPP AM, we analyse multiple viewpoints to separate a signal from the noise and identify the genuine forces driving change. In doing so, we aim to channel the opportunities catalysed by this changing world into long-term sustainable returns for our clients.
[1] https://en.wikipedia.org/wiki/MSCI_World
[2] Source: https://www.spglobal.com/spdji/en/index-family/equity/us-equity/#overview. Factsheet dated 28 February 2025
[3] https://staging.bnpparibas-am.co.uk/en-gb/professional-investor/portfolio-perspectives/talking-heads-watch-out-concentration-risk-ahead/
