The equity market is ripe for a broadening

Nicholette MacDonald-Brown - Head of Sustainable Equities
Nicholette MacDonald-Brown
Head of Sustainable Equities
Pascal Menges - CLIC Equities, CIO Office
Pascal Menges
CLIC Equities, CIO Office

key takeaways.

  • The dominance of US mega caps and other extreme conditions that have characterised equity markets in recent years may be due for a reversal, if history is any guide 
  • Such dynamics tend to be cyclical, with periods of concentration across industries, regions and market caps followed by periods of increasing breadth
  • Valuation anomalies now abound, presenting opportunities for active managers to identify undervalued stocks and sectors.

The extreme dynamics that characterised global equity markets in recent years – the dominance of the US and its mega-caps, and unrelenting flows to passive strategies – cannot last forever, in our view.

How could a reversal of these trends unfold, and what are the implications for active thematic strategies?

Elusive alpha

2024 was another strong year for equity markets, with the MSCI World climbing 19% after gaining 24% in 2023. Even so, investors struggled to achieve returns above the benchmark. The abnormal concentration of performance in a small number of US large caps in recent years has posed significant challenges for active managers striving to generate alpha.

We don’t believe this will continue indefinitely. In fact, we would argue that the backdrop for active management is growing more attractive and the opportunities outside the mega caps look increasingly compelling.

We touch on the key developments in the market below. By navigating the cyclical nature of active versus passive management, investors can position themselves for success in 2025 and beyond.

Read also: Passive equities have never been so concentrated: can active managers provide diversification?

An extraordinary rise

The US’s dominance within global equities is unprecedented in modern history. Accelerated foreign ownership of US shares has made the country a magnet for global capital, propelling its weight in the MSCI World Index to record levels.

FIG 1. US weight (in %) in the MSCI World1

The success of mega-cap stocks has amplified the market concentration. The top 10 US companies alone now represent about a quarter of the world equity index and almost 35% of the US equity market2.

The performance of the top 10 has been relatively stellar for almost a decade (see Figure 2). It accelerated during Covid as the move to remote work boosted the technology sector. The stocks also attracted investors during the Federal Reserve’s ‘jumbo’ interest rate increases from 2022 to 2024 to combat inflation. They are considered less rate-sensitive – driven by the recession-proof digitalisation/AI trend while generating material cash flows.

Figure 3 illustrates the challenge this dynamic created for active managers in 2024, and for thematic investing more specifically. It shows the performance of thematic buckets relative to the MSCI (both with and without the impact of the top 10). Few themes were able to keep up with the overall equity market performance.

FIG 2. Relative performance of top 10 US stocks3

FIG 3. A difficult backdrop for active and thematic investing in 20244

Investors have been right to focus on the top 10, with their earnings growth materially outpacing the market (see Figure 4). The question now is, will their growth advantage revert to normal?

FIG 4. Earnings growth comparison between MSCI World and TOP 105

What does history say?

In 2024, the number of stocks outperforming the world benchmark dwindled to record lows. History would suggest that this anomaly won’t last. As Figure 5 crucially shows, over a multi-decade period, we have not seen a steady trend of fewer and fewer outperformers. Rather, this has always been a cyclical factor, with periods of narrowness followed by breadth.

So the question probably shouldn’t be whether outperformance will broaden, but when.

FIG 5. Percentage of outperforming stocks within the MSCI World6

The same can be said for periods of market concentration. These have also tended be cyclical, lasting for a limited time before a change in leadership and increased breadth.

As Figure 6 shows, the last 15 years have been highly atypical, with leadership narrowing around a small number of stocks and the US the only place to be. The diversification of the equity market is currently the lowest it has been for a generation. It is not difficult to conclude that we could be reaching peak concentration.

FIG 6.

The last time market breadth rebounded in 2002 (from A to B in Figure 7), it benefited every segment in the overall equity market except US large caps. Hence, the opportunities for relative outperformance were much wider.

FIG 7.                                         

Narrowness has created opportunities

So, does all this suggest that the time has come to start diversifying across market sizes, industries and countries?

Valuation anomalies abound, with significant disparities in price-to-book ratios (see Figure 8). These present opportunities for active managers to identify undervalued stocks across sectors and countries.

Additionally, the relative drawdown of small and mid-cap stocks against larger caps indicates potential for these segments – across industries and beyond the US – to outperform as market conditions normalise.

FIG 8.

The superlatives for the current market are striking. If you exclude times of recession/crisis, this has been the most significant period of underperformance and valuation anomalies across market capitalisations in modern history (see Figure 9). 

FIG 9.

Active management: signs of rebound?

Another dynamic that is inherently cyclical is the performance of active versus passive management.

Inflows have been tilting toward passive funds as investors sought beta exposure while alpha generation was challenged. Except for a brief period in 2021, passive funds attracted more inflows than active funds for the past nine years. In 2024, total assets in US passive mutual funds and ETFs surpassed those in active ones for the first time.

Figure 10 would indicate that we are beginning to see a recovery in the performance of active funds.

In the past, when markets broadened following periods of concentration, active management usually outperformed. That would suggest that now is a good time to consider active strategies to avoid concentration risk.

FIG 10. Comparison of US active vs passive managers ranking15

Power of AI

Several macroeconomic and geopolitical factors are likely to shape the equity landscape in 2025, with potential to contribute to the broadening of market leadership.  

These include continued regionalisation and near-shoring trends (exacerbated by trade tensions) and government debt sustainability and fiscal consolidation/expansion. Other key developments include China's economic challenges, tipping points in global demographic shifts, and increasing cybersecurity issues.

Read also: Fitter, happier, more productive with general artificial intelligence?

Artificial Intelligence (AI) will remain in the headlines as the debate continues over how much it will transform industries and boost broader productivity.

We see the development of the economy’s `digital spine’ as a key part of the transition to a more sustainable economic model, determining how decisions are made around climate, nature and social issues. Technology is one of the key systems changes we focus on at LOIM for our Planetary Transition strategy.

Use cases for AI span several industries, including16:

loim/news/2025/january/30012025_CLIC-equities-outlook/icons/Transport_EV_car

Transport
 Self-driving cars, sensor technology and traffic prediction

loim/news/2025/january/30012025_CLIC-equities-outlook/icons/Healthcare

Healthcare
Diagnostics, drug prescription, personalised treatment and remote monitoring

loim/news/2025/january/30012025_CLIC-equities-outlook/icons/Finance

Finance
Personalised customer service, risk and investment management, fraud detection and real-time trading

loim/news/2025/january/30012025_CLIC-equities-outlook/icons/Manufacturing

Manufacturing
Predictive maintenance, generative design, quality control and supply chain optimisation

loim/news/2025/january/30012025_CLIC-equities-outlook/icons/Public_administration-Chatbot

Public Administration
Optimising service provision and AI-powered chatbots

loim/news/2025/january/30012025_CLIC-equities-outlook/icons/Education

Education
Personalised learning, tutoring systems, grading and educational content creation

For these reasons, we expect that AI will could be another contributing factor to the broadening of the global equity market in 2025 and beyond.

16 sources
view sources.
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1 LOIM, MSCI as at December 2024
2  LOIM, MSCI, as at 31/12/24. For illustrative purposes only.
3 LOIM calculation, as at 31/12/24. For illustrative purposes only.
4 LOIM, Bloomberg as at 31/12/24. For illustrative purposes only.  
5 Bloomberg, as at 31/12/24. For illustrative purposes only.
6 LOIM calculation, as at 31/12/24. For illustrative purposes only.
7 LOIM calculation of the number of stocks having a disproportionate market impact, based on Herfindahl-Hirschman Index.
8 LOIM calculation from 31/07/2011 to 30/11/2024. For illustrative purposes only.
For illustrative purposes only.
9 LOIM calculation. For illustrative purposes only.
10 LOIM, Bloomberg from 31/12/2001  to 31/07/2011. For illustrative purposes only
11 LOIM, Bloomberg as of 31/12/24. For illustrative purposes only.
12 LOIM, Bloomberg as of  31/12/24 calculation. For illustrative purposes only.
13 LOIM, Bloomberg as of 31/12/24 calculation. For illustrative purposes only.
14 LOIM, Bloomberg as of 31/12/24. For illustrative purposes only.
15 LOIM, Morningstar as of 12/31/24. For illustrative purposes only.
16 Discussion Paper - Artificial Intelligence: Economic Impact, Opportunities, Challenges, Implications for Policy – The European Commission, July 2024 
 

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This document is a Corporate Communication for Professional Investors only and is not a marketing communication related to a fund, an investment product or investment services in your country. This document is not intended to provide investment, tax, accounting, professional or legal advice.

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