Capital is rotating into Japan and emerging markets at the margins, but the sheer size of the US market keeps institutional investors anchored there
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on Public Equities.
Despite months of tariff escalation, geopolitical friction and stretched valuations, institutional capital continues to pour into US equities. But the question facing plan sponsors and asset allocators is whether that trade has further to run in developed market equities - and what diversification even looks like, especially when the US accounts for 70 per cent of total world capitalization.
“Buying US equities, that’s what the story still is,” said Grant Johnsey, head of market solutions, banking & markets, Americas, at Northern Trust. “There’s been a lot of both domestic investors in the US, institutional and retail, and even non-US investors that are putting money into the US market. That hasn’t really changed in a meaningful way. We have seen some money flow into emerging markets, many of which are headquartered or considered European in origination but those are more focused on global growth stories.”
Michael Greenberg, head of Americas portfolio management at Franklin Templeton Investment Solutions, agrees the US remains the top destination and is on pace for a record year of inflows, driven largely by tech-related investments, but acknowledged capital is starting to move elsewhere. He pointed to Japan and emerging markets that have picked up flows, with EM recording some of its strongest weekly inflows in some time.
“Japan, like many other markets, has some potential on the earnings front, but I think there is some room for a bit of rerating as well so you could get that double bonus,” he said.
Headwinds keep equity allocators underweight in Europe
Europe, by contrast, is not showing up as a major destination in the survey data.
Greenberg attributed the shift to a growing recognition that the AI-driven CapEx cycle, while durable, does not guarantee continued outperformance from the stocks most tied to it.
“With that volatility, people are just reevaluating that they might want a little bit more diversification in portfolios,” he said.
Greenberg acknowledged Franklin Templeton remains underweight Europe relative to its neutral long-term targets, not abandoning the region, but carrying less exposure than benchmark.
He cited several headwinds: elevated energy and gasoline prices driven by Middle East risk, manufacturing competition from China, and political instability in France and other countries with upcoming election cycles that could inject further volatility.
Together, he suggests those factors raise questions about whether European earnings can keep pace.
Still, he acknowledged that Europe trades at a valuation discount to other developed markets, noting that it has for years, making cheapness alone an insufficient reason to add exposure. He also suggests a de-escalation in the Middle East, a drop in oil prices, and stabilization on the fiscal and political fronts across the region would shift his view.
“That could be good for earnings and you could see a revaluation in that stock market, so I think there is some upside but it's more of a timing question, and we prefer to be a little bit on the sidelines, at least at this point,” Greenberg said.
On the equity side, Johnsey noted that US flows remain strong and positive through September despite tariff uncertainty and geopolitical noise. He attributed much of that persistence to a structural problem: most global equity markets are simply too small to absorb the capital that large institutional investors need to deploy.
Global equity markets too small for large institutional investors
Canada’s entire public market is roughly $5 trillion, while the Maple Eight pension funds alone hold over $2 trillion in assets while Australia’s stock market sits at about $2 trillion and Mexico’s is around $600 billion, which equals less than a single US mega-cap, noted Johnsey.
“If you're a superannuation fund in Australia, you have to look outside of Australian equity markets to deploy some of that capital and the US market being what it is and having the exposure on AI and tech trades that aren’t necessarily accessible everywhere else, it’s really hard not to have a pretty healthy exposure to US equities. That’s the feedback I get from a lot of global investors and that makes sense. That's why you see Carney talking a lot about why we need to figure out more areas for investment for our Maple Eights, our pension funds and our citizens to invest in local,” Johnsey said.
Yet, Greenberg believes the Canadian government’s push to diversify trade, build domestic infrastructure and reduce regulation will take years to bear fruit. He also argued that the broader global trend of economies decoupling from the US could improve the case for foreign equity diversification over time, as different regions develop growth drivers that are less correlated to the US engine.
Still, he cautioned against overreacting to the current trade friction. Canada sits next to the world’s largest consumer market, and that “political winds can change,” he said.
The more important implication, in his view, is that the investment required for economies to become more self-reliant - whether through reindustrialization, infrastructure or supply chain reshoring - will itself generate opportunities.
“As economies become maybe less reliant on the US to become more tied to other regions or even more self-independent, which is going to take a lot of investment, that’s actually going to create a lot of opportunities from an investment standpoint,” he said.
Fiscal spending fears outweigh tariff noise
Johnsey suggests trade policy uncertainty hasn’t yet reshaped how investors evaluate country-level equity risk in a meaningful way. Rather, the bigger shift, in his view, is a growing anxiety around fiscal spending.
When the US was the main offender running up massive deficits, he noted investors gave it a pass because of its reserve currency status and economic resilience. That tolerance is harder to extend now that Canada, Europe, the UK, Japan and China are all ramping up borrowing at the same time - driven by reindustrialization, critical minerals, AI infrastructure and energy investment.
The demand for capital, he argued, is likely the highest since the post-war period.
To that end, he flagged France and the UK “as the canaries in the proverbial coal mine”, noting that France’s inability to devalue its currency within the eurozone and the ECB’s unlikely willingness to intervene as it did for Greece are forcing investors to reassess sovereign bond exposure.
On the equity side, the tariff and geopolitical fallout has been muted so far. Most companies globally still carry positive earnings growth and enough pricing power to absorb or pass through tariff costs without crushing consumer demand.
“They've got good pricing leverage. So, even when the tariffs have come out, they have been able to take those tariff cost increases and through a variety of ways, either pass them on or rejigger their supply chains to offset and minimize their impact on their bottom line,” he said.
AI gains shift from enablers to adopters
Greenberg sees the productivity gains from AI spreading into non-tech sectors and down the market cap spectrum, creating openings in small- and mid-cap stocks. However, he underscored those companies can carry more exposure to higher interest rates and lower quality profiles, making active management and stock selection essential.
Beyond the US, he argued that regions with less direct AI exposure — Canada and Europe among them — could benefit if productivity enhancements filter through their economies.
The preferred destinations for capital rotating out of the US, in his view, are emerging markets and Japan, with Europe a longer-term possibility once geopolitical and domestic political risks in France settle. He acknowledged that European valuations look attractive on paper but cautioned against acting on that alone.
“Valuations are terrible timing tools, but that does suggest there’s an opportunity in some of those markets at some point as well,” he said.
