Shifting sands in global equities: return drivers point to potentially higher volatility and dispersion 

During 2003-10, global equity returns were broad-based and driven heavily by earnings growth. Exhibit 1 shows the components of total return for various FTSE equity indices during 2003-2010 on an annualized basis. For example, the FTSE USA index returned 7.0% on an annualized basis during this period. Much of the index’s growth came from earnings growth that contributed 7.1% while valuations contracted by 2.1% on an annualized basis. Dividend yield contributed 2.0% per year.

We note several characteristics of relative equity returns during this period which includes the GFC.

First, US equities lagged global peers both in the Developed and Emerging regions on an annualized basis, and earnings growth dominated US equity returns while valuations contracted (see “Decomposition of US equity returns over time-is it different this time?”). After the US Tech bubble burst and following an initial rebound in valuations, returns were driven by a recovery in earnings. This is a typical pattern seen after major market drawdowns and was repeated after the GFC.

Second, on an annualized basis, equities in the UK, Europe and Japan all saw higher earnings growth than US equities (besides higher total returns), although valuations contracted in all of them. UK and European equities also offered higher dividend yields than in the US, which tend to be more stable than the valuation and earnings growth components.

Third, China and other Emerging equities (represented by the FTSE Emerging ex China index) saw phenomenal growth during this period returning 27.8% and 22.9%, respectively, on an annualized basis. China became a member of the World Trade Organization in 2001 which opened global markets for Chinese manufacturing output and birthed an era of rapid economic growth which was mirrored by the country’s equities. Chinese equities saw annualized earnings growth of 21.7% along with a more modest 3.3% in valuation expansion and 2.9% in dividend yield. Emerging ex China equities were not far behind but saw a higher proportion of total return (5.3%pts or nearly a quarter of total return) from valuation expansion than Chinese equities.

As we have noted in the previous insight on US equity return decomposition, 2010 marked the height of the European Debt Crisis which dragged on for several more years embroiling more European economies. It also marked the beginning of a period of US equity outperformance of non-US equities. 

During 2011-24, European equities languished amid a regional debt crisis and a middling economic recovery post-GFC, and China’s economy began to slow down from its rapid growth phase. However, in the US, fiscal and monetary policy support with historically low interest rates laid the groundwork for US equity outperformance. The ample liquidity bolstered consumption and innovation in the form of venture funding, especially in technology, which set up US equities for a Tech industry-led rally toward the end of this period.

Exhibit 2 shows the components of total return for various FTSE equity indices during 2011-24 on an annualized basis. It is rather remarkable to note how little earnings growth and valuation expansion were part of non-US equity performance.

US equities returned 13.7% during this period on an annualized basis, nearly double the annualized return of the previous period (2003-10). While the earnings growth component at 7.8% was like the 7.1% earnings growth in the previous period, valuation expansion at 4.0% annualized also boosted total returns (while valuations contracted during 2003-10). It coincided with the rise of Technology’s weight in the US index^[2] and, with the promise of faster growth, Tech valuations tend to be higher than that of “traditional” industries.

By comparison, European equities returned 6.2% on an annualized basis during this period - a slowdown from 2003-10 and less than half of US equity returns during 2011-24. And about half of European equity returns came from the dividend yield component, with valuation expansion and earnings growth contributing very modestly. Equities in the UK and Emerging markets saw earnings contract on an annualized basis. Japanese equities did see earnings growth of 4.0% (second only to the US) but once again, valuations contracted modestly on an annualized basis.

Since annualized returns consolidate changes seen intra-period, we also looked at calendar year returns over the last 22 years but focus on the most recent calendar year. Exhibit 3 shows the return decomposition for 2024.

In 2024, the US still outperformed peers with strong valuation expansion and earnings growth, coming largely from the AI-fueled tech rally. However, it wasn’t just a US story.

In the UK, valuations bounced 7.0% as the UK’s Labor party came into power with the promise of higher investment in the economy. (UK valuations also expanded in 2023 after contracting during the earnings-driven 2021-22 post-Covid recovery.)

In Japan, although equities delivered strong earnings growth (11.6%), valuations contracted steeply (-5.8%). In 2024, Japan embarked on a historic monetary normalization by hiking policy rates which likely weighed on equity valuations.

In China, a slew of fiscal and monetary stimulus measures provided a boost to equities in the form of strong valuation expansion (16.2%). However, earnings growth was minimal (0.4%).

Emerging ex China equities, whose largest constituents are India and Taiwan^[3], saw relatively stronger earnings growth of 4.7%.India in particular has a strong structural growth story.

This was the picture coming into 2025. US policymakers were preparing for a soft economic landing, whereby inflation was expected to approach the US Fed’s target without a negative demand shock to the economy. UK equities were showing promise with more positive investor sentiment. Chinese equities reflected a more optimistic investor outlook in response to government stimulus measures. And while the new US administration’s tariff policies were expected to be a challenge for those countries with large trade surpluses with the US, much of the details were yet to come.

During the first five months of 2025, we have seen much volatility in global equity markets, to say the least. We examined the return drivers for Q1 2025 and, separately, April-May 2025 which marked an escalation in global trade tensions with the US’s “Liberation Day” tariffs announcement and the subsequent pause in their implementation which nevertheless sustained uncertainty for markets. Exhibits 4 and 5 show the total return decomposition for various FTSE equity indices during Q1 2025 and April-May 2025, respectively.

Announced US tariffs were much higher than anticipated, once again raising the specter of high US inflation and interest rates. The outlook on private consumption spending and the overall economy cooled. Further, the release of China’s DeepSeek AI model threw into question the expected return on heavy capital investment by US Big Tech companies. Sentiment toward US equities shifted quickly to the downside. US valuations pulled back sharply in Q1 (-7.4%).

An equally important shift happened in Europe. Germany’s loosening of fiscal restraints for defense spending and additional planned infrastructure investment boosted the outlook for European equities. UK and Europe saw both strong earnings growth and valuation expansion in Q1 and April-May.

Japanese equity valuations continued to contract in Q1 (-7.2%) as the central bank continued to tighten. Further, Japanese equities have historically been negatively correlated with the yen, which has strengthened on relative interest rate differentials since 2024 and during the flight to safety in 2025 thus far.

Chinese equities rallied strongly in February as its Tech industry received a boost from the release of its DeepSeek AI model. However, escalating trade tensions with the US and tepid domestic consumption continued to weigh on Chinese equities. We saw this through a strong bounce in valuations and earnings growth during Q1 but a contraction in both during April-May.

Broadly, Emerging ex China equities showed modest earnings growth (1.2%) and sharp valuation contraction (-5.0%) in Q1 as their economies were in the midst of navigating the US tariff policy landscape.

Broadly, starting in mid-April through the end of May, valuations bounced across markets, including the US, Japan and Emerging, in a “relief rally” after the US paused the implementation of “Liberation Day” tariffs. However, tariff policy uncertainty remains. 

The data on return decomposition provides a few takeaways.

The extent to which valuation expansion had contributed to US equity performance during 2011-24 implies that US equities may be more susceptible to shifts in investor sentiment than previously as we saw in Q1 2025. It could also mean that US equities’ YTD (through May) underperformance of global peers may have room to continue amid rapidly shifting investor sentiment.

For European and UK equities that have shown both earnings growth and valuation expansion during January-May 2025, it remains to be seen whether the planned fiscal spending and investment will translate into sustained equity earnings growth. The current positive investor outlook could prove to be a tailwind for valuations to expand.

The Chinese equity rallies in 2024 and Q1 2025 have largely depended on shifts in investor sentiment and valuation expansion that have reversed quickly. Again, it remains to be seen if government support will be successful in sparking higher domestic consumption as China attempts to reduce its economic reliance on external demand, and if this will translate into earnings growth.

Japan’s desire to normalize its monetary policy environment may mean in the short term that interest rate differentials continue to move in favor of the yen strengthening and potentially weigh on valuations even if Japanese equities deliver earnings growth.

Emerging ex China equities still face high uncertainty as US tariff negotiations with China and other emerging economies play out, potentially weighing on investor sentiment and valuations during that time.

While markets face many sources of global and domestic uncertainty, we may be at a point where investors can no longer take US equity outperformance for granted. They may need to pay closer attention to the idiosyncratic drivers of earnings growth and valuation expansion in different regions, which may move in different directions, and prepare for a period of higher volatility and dispersion of returns as the status quo is challenged in different markets.

[1] We start our return decomposition analysis with 2003 due to the availability of component data for total return since that year.

[2] As of May 2025, Technology constituted 36.7% of the FTSE USA index.

[3] As of May 2025, India and Taiwan constituted 32.2% and 28.4%, respectively, of FTSE Emerging ex China by weight.