Barometer: EM stocks set to remain at top of leaderboard

Asset allocation: outlook for equities remains positive

Equity markets have seen a positive start to the new year, and the key ingredients are there for more gains.  Liquidity conditions are favourable, governments around the world are increasing public spending (be that Japan, US or Germany), economic growth prospects are solid and inflation appears to be in check (see Fig.2) . We therefore continue to overweight equities and underweight bonds, and have increased exposure to industrials and emerging markets.

The business cycle indicators we monitor support our view. In the developed world, economic conditions are positive in the US, euro zone, UK and Switzerland. But it is in emerging markets (EM)  where growth appears especially strong. We expect the gap in GDP growth between emerging and developed economies to widen to 2.5 percentage points this year from 2.3 percentage points in 2025, paving the way for outperformance of EM assets. Higher commodity prices could provide a further tailwind, particularly if the US dollar weakens further.

Conditions in China are less clearly positive than elsewhere in EM. Growth is meeting the 5% government target, but the economy is struggling to shift from export-led to domestic demand-driven growth.

In the developed world, the US economy is supported by positive corporate sentiment and hiring intentions. However, we are concerned about the fact that household spending is being funded by savings rather than income – a situation which is unlikely to be sustainable over the medium term.

For Europe, growth prospects hinge on the effectiveness of planned fiscal stimulus and infrastructure spending, particularly in Germany. Structural reforms – such as the EU Capital Markets Union, labour market improvements, and energy diversification – could provide further catalysts for growth. On the flip side, the strength of the euro remains a risk for the region’s exporters.

Currency appreciation and its potentially negative effect on exports is also an issue in Japan, where the upcoming snap elections could open the door to a large publicly-funded stimulus package. This supports the case for tighter monetary policy. Boosting the currency will, in our view, be a priority for the BoJ. We expect the central bank will continue to normalise its balance sheet, raise interest rates in both April and December and intervene in the foreign exchange markets. If inflation momentum persists, there is a risk that central bank tightening could temper Japan's GDP growth. 

Our liquidity indicators point to more gains for riskier assets. Of the central banks we monitor worldwide, 17 (57%) are easing, 12 (40%) are neutral and only Japan is tightening. The first group includes the Fed, which in addition to easing policy has recently pivoted from quantitative tightening to supporting the economy through reserve management purchases (RMPs) of T-bills.

While easy monetary policy continues to support equities, the persistence of this stance – especially as businesses continue to spend freely on AI and governments such as the US test their own fiscal limits – means risks are building beneath the surface. The longer this persists, the greater the probability of a sudden shift in investor sentiment particularly if inflationary pressures resurface.

Our valuation metrics also point to factors that could upend the rally. But in the short term at least, risk premia are still at historically low levels: in the US, for example, the difference between the 12-month earnings yield and 10-year Treasury yield stands at 2.7%, 7 percentage points below its peak. Global earnings sentiment continues to improve and the risk of a sharp earnings slowdown is low.¹

Following recent underperformance, US stocks are no longer the most expensive equity market. However the S&P 500’s price-to-earnings multiples remain stretched at 22 times offering a limited buffer if growth declearates and inflation picks up. 

Technical indicators suggest global equities are still supported by improving market breadth - the fact that a growing number of stocks are participating int the rally. Inflows into equities remain solid (at USD72 billion in the last four weeks), led by global benchmarks, EM and US. Retail and institutional investor surveys show a clear risk-on stance, with fund managers surveyed by Bank of America to most overweight on equities since 2024.

Equities regions and sectors: follow the AI boom into EM

Ongoing monetary and fiscal stimulus worldwide and the prospect of looser business regulations in the US continue to make equities an attractive asset class. But it is in emerging market (EM) stocks where the greatest opportunities lie. We have increased our exposure to EM stocks ex-China and also maintain an above-benchmark allocation to Chinese equities.

A weaker US dollar, ample global liquidity and increased intra-regional trade continue to draw capital into EM assets while strong commodity prices also benefit resource-rich markets such as Brazil and South Africa.

We expect EM companies to deliver the highest earnings growth in the world this year at above 11%, above that of US and Japanese firms, both at 10%, and double the rate we forecast in the UK, Switzerland and the euro zone.

We expect particularly strong gains among EM technology and communication services in markets such as Korea, Taiwan and China. They stand to gain from strong demand for AI hardware and semiconductors and as supply chains continue to be reconfigured in their favour due to geopolitical and trade tensions. As the AI rally broadens beyond a narrow group of US tech  heavyweights, EM hardware and semiconductor stocks are gaining.

Chinese stocks, meanwhile, should draw further support from ongoing regulatory and monetary and fiscal policy loosening. and from the temporary improvement in US-China trade relations. 

Beyond emerging markets, we keep our overweight stance in Swiss stocks, which are supported by strong corporate fundamentals and the country’s stable macroeconomic environment. European stocks remain at benchmark-weight as we await the impact of interest rate cuts and fiscal support to feed through intostronger corporate earnings.

When it comes to sector allocation, technology and communication services remain our core overweight positions. We favour firms supplying chips, servers, data centre hardware and cloud and network storage – while software companies, by contrast, face near‑term pressure from rising computing costs and the limited availability of AI-grade chips and memory.

We upgrade industrial stocks to overweight - a sector that we expect to benefit from higher global capital expenditure, increases in European public spending and strong economic growth dynamics.

Healthcare also remains an overweight thanks to the sector’s defensive properties – which make it a good hedge against a possible market retrenchment - and attractive valuations; it remains the cheapest sector on our global valuation scorecard. Increased M&A activity – where large healthcare and pharma companies are buying up smaller innovators to access new technologies and cut costs – should also help unlock value for shareholders.

Stronger growth momentum and a steeper bond yield curve are broadly supportive for banks and insurers, and we remain overweight financial stocks. But, increasingly, investors need to be selective, especially in the US. The White House’s push to make everyday finance more affordable – for example by capping credit card rates and fees or tightening rules on mortgages – could squeeze banks’ revenue and profitability. Election-related rhetoric and legal risks may also affect some financial firms more than others.

Fixed income and currencies: JGBs beginning to look cheap

Japanese government bonds (JGBs) look increasingly attractive on valuation grounds after their recent selloff. But while we don't believe the country is threatened by a debt spiral, there’s still the risk that yields will rise slightly from current levels before they move back down more decisively. As a result, we maintain our neutral stance.

The selloff in JGBs has been most pronounced in the long end of the yield curve, driving the yield on the 30-year JGB towards 4%, while the yield on the 10-year bond is some 2.2%, the highest it has been in 20 years. There are a number of forces driving these moves, including prospects of a fresh fiscal stimulus package. This, in turn, raises concerns about the country’s debt sustainability – Japan’s debt to GDP ratio is north of 220%.

We believe fears of a debt debacle are misplaced. While relative to recent trends the move in Japanese yields has been material, a positive reading of these developments is that they reflect an improvement in Japan's economic performance. As Fig. 4 shows, yields have been moving up in tandem with nominal Japanese GDP growth.  

And while Japan certainly has a very high headline level of national debt, the country’s high nominal GDP growth has reduced the country’s debt to GDP ratio by some 30 percentage points since its peak in 2020, according to IMF data. At the same time, most of that debt is held domestically, a high proportion of which by the Bank of Japan itself, and the Japanese have considerable holdings of foreign assets, sufficient to cover obligations to foreign holders of its debt.

Market concerns about US Treasury bonds look similarly overblown. Investors are clearly worried about the unpredictability of economic and trade policy in the US and about stewardship of the Fed once President Trump chooses his candidate for chairman when Jerome Powell’s term ends in May. But so far those fears have largely shown up in dollar weakness and gold’s meteoric rise. Treasury bonds remain the main risk-free asset for global finance.

We do, however, expect the dollar to remain vulnerable to further losses. Comments and shows of support for a weak dollar from the US administration – particularly in favour of, for example, a stronger yen or Korean won – suggest space for further downside. And whereas the dollar had previously been negatively correlated to US equities, it now shows a small but positive correlation. This gives foreign investors a strong incentive to hedge currency risk on their US equity holdings, which puts further downward pressure on the dollar. As a result we maintain our overweights in the euro and Swiss franc alongside gold – notwithstanding the understandable desire on the part of Swiss authorities to restrain the franc’s relentless appreciation.

Dollar weakness also underpins our overweight in local currency emerging market debt (ex-China). These economies have largely been able to shrug off the effects of America’s tariff war and have also benefited from strong domestic economies – with a number of Asian economies integral parts of the AI supply chain.

Global markets overview: risky assets roar; dollar suffers

Equities started the year with solid monthly gains of 2.5% in local currency terms, outperforming bonds which ended January barely changed. 

The rally in stocks reflected optimism over a broad-based improvement in corporate earnings and continued monetary stimulus from the world’s major central banks.

But while many indices hit record highs, markets were volatile, with investors contending with the US's toppling of Venezuela's president and President Trump's threat to impose tariffs on countries that opposed his plan to control Greenland. 

Energy and material sectors saw the sharpest rises, mirroring recent gains in gold, commodity and oil prices. The materials sector has the second-highest earnings growth rate of any sector in the first quarter at over 24%, according to LSEG.

There was pronounced dispersion within the tech sector, however, with software stocks down by nearly 10% but memory chip-related stocks gaining as demand surged for specialised technology hardware.

When it comes to regions, the biggest gains were found in emerging markets. Resource-rich Latin American markets benefited from higher commodity prices, while emerging Asia was supported by its exposure to technology. The US lagged with gains of just over 1%; Japanese stocks ended the month up nearly 5% in local currency terms, with the Nikkei index hitting an all-time high.

In fixed income, Japanese government bonds (JGBs) fell nearly 1% in local currency terms on the month, bringing losses since the start of 2025 to over 5%. Yields on longer-dated JGB hit all-time highs as investors fretted over Japan’s already stretched public finances after Prime Minister Sanae Takaichi announced a snap general election in February and floated a two-year suspension of the 8% food sales tax as part of her campaign.

US Treasuries also ended the month down due to resilient economic data. Corporate bonds across both sides of the Atlantic ended the month more or less unchanged. 

Gold experienced a volatile month, hitting a fresh record high above USD5,500 an ounce before retreating sharply after President Trump nominated Kevin Warsh, a former Fed governor and harsh critic of the Fed's quantitative easing policies, as the next chair of the US central bank. 

The precious metal ended the month 10% up since the start of the year, the best monthly gain since 1999. Copper and silver prices also hit fresh records before a sharp sell-off. Oil gained 16%.

In currency markets, the dollar fell over 1% while the Swiss franc was the biggest gainer, ending the month up 2.5%. The euro and sterling rose more than 1%, while the yen hit a three-month high against the dollar.