Anatomy of a Market Rotation

 

And you better start swimmin’
Or you'll sink like a stone
For the times they are a-changin’
— Bob Dylan

“No one goes there anymore. It’s too crowded.”
— Yogi Berra

 

For global markets, and in particular the US market, 2024 was a vintage year. The S&P ended the year up around 24%, and the Nasdaq soared by 32%, led by AI chipmaker NVIDIA, which jumped 170%, having risen tenfold since the launch of ChatGPT in October 2022. Amid the popping of champagne corks, it bears reminding that the market’s stellar rise was by no means a foregone conclusion. In fact, 2024 started in a rather subdued mood, with widespread expectations of an economic “soft landing” or even an outright recession, and low earnings growth expectations. As the year progressed, and positive economic and earnings surprises came in fast and hard, US markets rose along with them. International (non-US) markets, meanwhile, lagged, as economic expectations and earnings growth failed to ignite investor enthusiasm.

2025 thus started in a more ebullient mood than the year before. US projections for both economic and earnings growth were elevated. Belief in “American exceptionalism” reigned supreme. And the election of Donald Trump added to the giddiness. Trump II, so the consensus had it, would be a better-executed repeat of Trump I: tax cuts, deregulation, and peace on earth. Meanwhile, international equities were once again burdened by the weight of low expectations.

One quarter in, the tape looks radically different from what was expected: the S&P is down 3.2%, led by the “Magnificent 7” down 12.3%; the MSCI Europe is up 12.3%, led by the DAX up 13.9%; and China is up 17.2%. What happened?

Valuation and positioning are good starting points. At the start of 2025, US markets screened as their most expensive in decades across a variety of metrics. These ranged from the stock-specific, such as earnings multiples and free cash flow multiples, to the broader, such as the equity risk premium (measuring the additional return over 10-year Treasuries) and one of Warren Buffett’s favourites, total market cap to GDP. In contrast, international stocks were cheaply valued — both in absolute terms relative to their historical averages, and relative to the US.

And even though investors often talk about buying cheap stocks and selling expensive ones, almost none actually did so in the course of 2024. Positioning at the beginning of 2025 was extreme, with more investors than ever favouring US stocks over international ones. Domestic inflows into ETFs tracking the S&P 500 soared, climaxing after Trump’s election. At the beginning of 2025, US households held the highest share of their net worth in equities on record. Meanwhile, global investors — from Europe to Southeast Asia — bought into the narrative of American exceptionalism and were record overweight US equities relative to their own regions.

Not even a month into 2025, this apparently unassailable status quo — expensive, overowned US stocks and cheap, underowned international stocks — was disrupted by four developments: first, the emergence of MAGA as the driving ideology in US policy; second, the awakening of Europe; third, a course correction in China; and fourth, a reassessment of the AI narrative. All of this happened simultaneously and at great speed. Or, as Vladimir Lenin once put it: “There are decades where nothing happens; and then there are weeks where decades happen.”

We examine each of these changes below.

 

 

Those who believed Trump should be taken seriously but not literally were in for a rude awakening. True to the MAGA ideology, Trump embarked on a series of highly disruptive policies. First, he launched a trade war, targeting both foes and — especially — allies with tariffs, imposed and withdrawn in chaotic fashion. Second, he abandoned the Atlantic alliance by aggressively confronting EU members and aligning with Russia against Ukraine. Third, he attacked establishment institutions — universities, the press, the judiciary, and the civil service — both rhetorically and by defunding them via Elon Musk’s DOGE. Fourth, he created further uncertainty for corporations by slashing regulations. Fifth, he cracked down on immigration. And sixth and finally, despite the DOGE spectacle, he worsened fiscal imbalances by enacting tax cuts.

Europeans, shell-shocked by the ferocity of Trump’s actions and rhetoric, awakened from a decades-long slumber. First, they rushed to ramp up defence spending, from negligible levels to as high as 4% of GDP. Second, Europe’s “sick man”, Germany, committed to an ambitious infrastructure plan to stimulate economic growth. Third, there was renewed momentum to implement the regulatory and pro-growth reforms proposed by Mario Draghi in his report on EU competitiveness. And fourth, to finance all of the above, fiscal restraints were loosened and new instruments such as common bond issuance were explored.

Less in reaction to Trump and more as an attempt to revive its struggling economy, China’s CCP launched a series of ambitious policy initiatives. First, it broke with five years of erratic regulation and committed to stabilising the regulatory framework, especially for previously fast-growing tech firms. Second, in addition to accommodative monetary policy, it introduced a number of initiatives aimed at directly and indirectly supporting consumers. Finally, it promoted domestic investment in Chinese equities by both institutional and retail investors.

As if this political turmoil weren’t enough, the dominant market narrative — that of an AI capex supercycle driving semiconductor and data centre demand — began to unravel in Q1. First, seemingly out of nowhere, Deepseek, a Chinese LLM, challenged the assumption that model performance scales linearly with compute. This led investors to question the sustainability of demand for data centre capacity and semiconductors. Second, the IPO of CoreWeave exposed the opaque financing arrangements underpinning much of the AI ecosystem — from vendor financing to cross-shareholdings and SPVs — evoking memories of the fibre-optic bubble in the late 1990s. Third and finally, a gaping hole remains at the heart of the AI narrative: the absence of meaningful end-user revenues, with widespread adoption of LLMs still some way off. As a result, returns on investment — for what were once capital-light businesses — are under pressure.

With changes in these four areas unfolding at breakneck speed, investors found themselves wrong-footed. Maximum-bullish positions in US equities were reduced — led by the AI-driven technology sector, which also happened to be the most overowned and expensive segment of the market. Investors rotated into European equities, especially defence, banks, and infrastructure plays. Chinese stocks, particularly technology names, staged a scorching rally.

So what is to be done?
The current volatility reinforces the importance of diversification — across geographies, sectors, themes, and asset classes — something we at Econopolis have always emphasised. Moreover, today’s market favours active management and stock picking over passive index-tracking. The ongoing rotation illustrates that while excessive trading rarely leads to good outcomes, inactivity can be just as costly. A rigid commitment to a single trend or sector typically results in underwhelming long-term returns, as the global landscape constantly shifts, with industries and companies rising and falling.

Or, as Bob Dylan once put it: “For the loser now will be later to win.”

Only active managers could have avoided highly valued momentum stocks in favour of cheaper laggards. And only an active underweight in US technology — in favour of other sectors or regions — would have resulted in outperformance. In addition, sideways-to-downward trending markets call for downside protection. This means not only reaffirming bottom-up convictions and testing portfolios for hidden weaknesses, but also seeking out opportunities in Bonds — or even Gold — to offset volatility.

Finally, and most importantly, as I wrote at length in a 2023 article titled Embracing the Long Game in Turbulent Markets: don’t panic. Great long-term returns in equities are available to investors who are patient, rational, and long-term oriented. But they are not free — volatility is the price of admission.

The ongoing rotation confirms what The Psychology of Money author Morgan Housel put so well: “Nothing is ever as good as it seems or as bad as it seems.” A fixation on US exceptionalism and technology growth can blind investors to opportunities with far better risk-reward profiles in unloved sectors or geographies.

The current rotation serves as a timely reminder to keep an open mind. In The Crack-Up, F. Scott Fitzgerald famously wrote:

“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.”

But it’s the line that follows that rings especially true for today’s investors in European and Chinese equities:

“One should... be able to see that things are hopeless and yet be determined to make them otherwise.”