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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief global equity strategist and head of macro research in Europe at Goldman Sachs and author of ‘Any Happy Returns’
At a time when transatlantic trade tensions are mounting, it might seem an inopportune time for investors to diversify their portfolios away from the US to Europe. After all, President Donald Trump has warned he is planning to impose a 25 per cent additional tariff on goods from Europe, raising questions over the fallout on the region’s economies and companies.
But this year has clearly shown that the market consequences of such ructions can be very different from what investors expect. In a more uncertain world, that puts a premium on diversification.
At the end of last year, the term “US exceptionalism” was everywhere, and for good reason. The US equity market had outperformed the rest of the world consistently for the best part of 15 years. This was not irrational, but rather a reflection of its superior fundamentals. The US had generated significantly superior earnings growth relative to other markets ever since the financial crisis.
The success of the US corporate sector owed much to the extraordinary profitability of the technology sector, which has increasingly been concentrated in a few megacap companies. By the end of last year, the biggest 5 tech companies in the US made up nearly 30 per cent of the value of the S&P 500 index, a record high.
These consistent patterns of repeated success rewarded investors who had concentrated their exposure in the US equity market, technology and a handful of companies. Diversification — once described by Nobel Prize winner Harry Markowitz as the “only free lunch” in investment — failed to boost risk-adjusted returns. But repeated success drove valuations of the winners to record relative highs.
Valuation gaps can remain large and persistent for long periods. It is typically only when underlying fundamentals shift that valuation extremes start to unwind. This is where expectations can play a big part. What really matters for financial market performance is not so much the path of future outcomes, but rather the outcome relative to expectations. Europe and Germany are a good example.
The relative weakness of the European economy compared with the US over the past decade has been in no doubt. The lack of European exposure to tech and issues related to high energy prices were well-understood. Nevertheless, investors came into this year too optimistic about the continuation of the trends in equities that have defined the past decade, while they were too bearish about the scope to diversify as a way of boosting risk-adjusted returns.
Since the start of this year, markets have begun to question these assumptions, leading to broader investor opportunities. First, the US equity market is underperforming others, particularly Europe. Most European indices are up 12 per cent or more in dollar terms so far this year relative to a flat performance by the S&P 500.
The German stock market performance has been even more striking. So far in 2025, the Dax 40 index is seeing the second-best start of the year since German reunification, rising 13 per cent in euro terms and 15 per cent in dollar terms.
Second, at the sector level too, opportunities to diversify have often been overlooked. European banks are much smaller than leading US tech companies and so attract less attention, but they have been performing as well for a couple of years. European banks are up 20-25 per cent year to date while the US tech sector has fallen.
Third, several themes are, for the first time in a long while outperforming US large-cap tech. The emergence of new competition from China has reignited interest in the country’s tech stocks (up more than 35 per cent from a January low to their recent high).
Meanwhile, in Europe, there is the prospect of lower gas prices if we see a Ukrainian peace deal, the potential for increased fiscal spending following the German election and a pick-up in European governments’ push to deregulate and stimulate growth. Things may not be quite as bad as the markets have been pricing.
Expectations and valuation matter. Diversification is a good way of spreading exposures to boost risk-adjusted returns over long periods of time. While circumstances have worked against this approach for much of the past decade, the benefits of diversification are reasserting themselves.
