A dynamic market creates new sectoral diversification opportunities

Market developments during the first half of 2025 have challenged many prevailing assumptions, including that of US economic and market exceptionalism which had dominated over the last 15 years. Economic policy uncertainty rose to historically high levels contributing to market volatility. Under such conditions, typical safe-haven trades such as higher demand for the US dollar and Treasuries did not materialize. Investors were in uncharted waters. Such recent market movements argue for greater diversification for multi-asset investors, and lower correlations between risk assets over the last 12 months are expected to be supportive of this^[1]. 

In this insight, we outline several industry and sectoral implications from recent macroeconomic and market developments.

Two critical developments in the first half of 2025 checked the broad-based equity rally that we saw toward the end of 2024. First, the new US administration’s announced tariff proposals were far higher than initially anticipated by the market, triggering fears of retaliatory tariffs and adverse impacts on global trade and economic activity. Second, the release of China’s DeepSeek AI model questioned the return on heavy capital investment in AI technologies made by Big Tech companies and their rich stock valuations. These specific shocks were followed by a slew of softer economic sentiment indicators in the US, even while in Europe the outcome of Germany’s elections and planned fiscal stimulus provided a boost to its economic outlook. In sum, starting around mid-February, defensive industries started outperforming cyclicals in the face of high uncertainty, as illustrated in Exhibit 1, which shows the cumulative return spread between FTSE All-World cyclical and defensive industries since end-2024.

In early-April, the announcement of reciprocal tariffs by the US gave an additional shock to markets. But, when those tariffs were paused a week later, markets found renewed optimism despite sustained trade policy uncertainty, and cyclicals performance recovered relative to defensives. The US subsequently entered into framework trade agreements with the UK, Europe and Japan, among others, which continued to fuel market optimism. By end-July, cyclicals were well ahead of defensives for 2025 on a cumulative basis.

However, this broad cyclical-defensive split does not quite capture some of the industry-specific drivers of returns that played out in addition to the cyclicality of the market.

Take the case of Consumer Staples and Consumer Discretionary. Historically, softer consumer sentiment data has been correlated with lower levels of household discretionary spending, making the case for Staples over Discretionary equities. We have seen this relationship play out recently.

Exhibit 2 shows the cumulative return spread between FTSE All-World Consumer Staples and Consumer Discretionary industries alongside the University of Michigan Consumer sentiment index in the US (a lower number indicates worsening sentiment). As consumer sentiment has worsened in the US, this has been supportive of Staples’s outperformance of Discretionary during January-April 2025. More recently, we have seen consumer sentiment in the US improve slightly during June and July, and a reversal of that relative performance. It underscores the link between macro indicators and specific industry performance.

Another example of an industry-specific performance driver is related to Financials. Global monetary easing over the last 12-18 months in response to declining inflation has contributed to steepening sovereign yield curves in several major developed markets. And steepening curves have generally been associated with periods of Financials outperformance; another trend we have seen recently.

Exhibit 3 shows the FTSE All-World Financials industry’s cumulative return spread over the FTSE All-World global benchmark over the last three years alongside the slope of the US sovereign yield curve, i.e. the spread between US short- and long-term yields. As this spread has risen recently, so has the Financials industry’s outperformance. And to the extent that there is room for further steepening of yield curves, this could be a potential tailwind for Financials.

The recent market uncertainty and volatility have had implications beyond equity sectors. Gold and precious metals have performed well during January-July 2025, with gold continuing to breach all-time highs in recent months. Historically, gold prices have tended to increase during periods of elevated economic policy uncertainty, which has provided momentum to this trend.

Exhibit 4 shows the rise in the price of gold alongside the rise in the World Economic Policy Uncertainty (EPU) index to illustrate this relationship. (While the EPU index is slightly lower since April, it still reflects elevated policy uncertainty relative to history.) 

De-dollarization and economic fragmentation have also been structural tailwinds for gold, as central banks have increased gold holdings over the last 10 years, most notably in China, Turkey, Hungary and Poland^[2]. 

We have discussed market cyclicality and the industry-specific drivers that play alongside them. But, in a dynamic market environment, investors should keep an eye on the cyclicality of industries themselves. 

Beta is a measure of cyclicality that considers an industry’s correlation to the broader market and its relative volatility. We often think betas are fixed, but they can be different in different markets. Since they are measured relative to a benchmark, differences in the index’s industry composition can have a big effect on industry betas. This is illustrated in Exhibit 5, which shows the industry betas for the FTSE All-World, FTSE USA and FTSE Developed ex USA indices measured over the 36-month period ending in July 2025. The Consumer Staples and Utilities industries show a notable difference in beta or cyclicality between the USA and Developed ex USA markets, as do other industries to a lesser extent.

Even more interesting, betas can change over time. Exhibit 6 shows the rolling 36-month betas for select FTSE USA industries that have changed in a notable way over the last five years.

Over the last five years, in the US, we have seen Energy’s beta fall from 1.24 in July-2019 to 0.7 in July 2025. Similarly, Consumer Staples’s beta has fallen but to a lesser degree. On the other hand, Utilities beta has risen from 0.29 in July 2019 to 0.59 in July 2025, as has the beta for Real Estate. Some of these changes in beta may be driven by structural shifts that are more enduring than others.

For example, with the heavy investment in AI technologies over the last two years, electricity demand for data centers and computing has skyrocketed. The Electricity sector, which is part of the Utilities industry has benefitted from the AI-fueled cyclical rallies in the US market and driven the Utilities industry’s beta higher. Investors may not have expected a traditionally defensive industry to benefit from this trend.

Another case is the recent drop in Energy’s beta, which points to the industry’s disconnect from economic growth. The FTSE All-World Energy industry’s returns over the last 10 years have been more correlated to the price of oil, which has been influenced by structural excess supply, than to indicators of economic activity that impact oil demand. 

The implication for investors is to recheck their assumptions on the cyclicality of different pockets of the market whilst trying to achieve their desired exposures.

The first half of 2025 posed new challenges for investors as policy uncertainty rose to historic levels, traditional relationships between macro and market indicators were challenged, and expectations for future returns were altered. However, this market environment also created new diversification opportunities for investors. In this insight, we have described how market cyclicality impacted cyclicals-defensive performance during January-July 2025 and how the cyclicality of industries themselves have changed in response to structural changes. Beyond cyclicality, industry-specific drivers of returns merit consideration. In this dynamic market environment, investors should re-check their assumptions on correlations and cyclicality whilst seeking diversification.

1. FTSE Russell Global Wealth Research July 2025. See pg. 7.

2. FTSE Russell Asset Allocation Insights June 2025. See pg. 12 on Commodities.