A Historic Shift in Global Equity Markets: Q3 2025 Capital Market Assumptions
· Phil Taylor
As we close out the third quarter of 2025, FinMason's latest Capital Market Assumptions reveal a watershed moment in global equity markets—one that should fundamentally reshape how investors think about portfolio construction and geographic diversification.
A Ten-Year First: North American Equities Below 2%
For the first time since we began running our long-term linear regression models a decade ago, our ten-year expected return for North American Equities has fallen below 2%, dropping to just 1.86% as of September 30, 2025. This represents a dramatic decline from the 2.87% expected return we projected just three months earlier at the end of Q2.
This isn't a minor adjustment—it's a 101-basis-point collapse in a single quarter, signaling that North American equity valuations have reached levels that simply cannot sustain historical return patterns over the next decade. With an R-squared of 0.93, this is one of our most statistically robust models, giving us high confidence in this sobering projection.
The Global Opportunity Has Never Been Clearer
While North American markets have become historically expensive, the opportunity set elsewhere in the world has expanded dramatically:
Developed Asia Equities now offer the most compelling developed market opportunity, with expected returns surging from 5.32% in June to 7.57% in September—an increase of 225 basis points in a single quarter. This region now offers a remarkable 571 basis point premium over North American equities.
Developed Europe Equities similarly strengthened, rising from 6.47% to 7.20%, providing a 534-basis-point advantage over North America. The consistency of this projection (R-squared of 0.82) reinforces the validity of this opportunity.
China Equities, while declining slightly from 10.15% to 9.46%, still offer the highest expected returns in our entire model set—a full 760 basis points above North American markets. However, investors should note the lower R-squared (0.75) suggests higher uncertainty around this projection.
Emerging Market Equities present an interesting counterpoint, with expected returns declining from 5.79% to 5.18%. While still offering a 332 basis-point premium over North America, this marks a divergence from the developed-market trend and warrants close monitoring. That said, with an R-squared of 0.88, this remains one of our most reliable models.
The Small Cap Growth Opportunity
Beyond geographic diversification, our Fama-French factor analysis reveals another compelling insight: Small Cap Growth stocks are positioned for meaningful outperformance.
The Size factor (Small Minus Big) stands at +1.09% with a strong R-squared of 0.86, indicating that small-cap stocks are expected to outperform large caps by over 100 basis points annually. Meanwhile, the Value factor (Value Minus Growth) shows -0.86% (R-squared 0.71), suggesting growth stocks will outperform value by a similar magnitude.
Combined, these factors indicate that small-cap growth strategies could add nearly 2% in annual alpha over the next decade—a dramatic reversal from the large-cap value dominance we've seen in recent years.
Fixed Income and Rate Environment: A Complex Picture
The interest rate environment presents a nuanced picture:
Short-term rates have declined significantly, with the 3-month rate falling from 4.00% to 3.02%—a signal that the Federal Reserve may be entering an easing cycle. However, longer-term rates remain elevated:
- 10-Year Treasury: 4.16% (down slightly from 4.24%)
- 30-Year Treasury: 4.73% (down from 4.78%)
The 1-year and 5-year rates (1.46% and 1.92% respectively) suggest the market anticipates continued economic uncertainty in the intermediate term before normalizing at higher long-term rates.
Credit spreads have tightened, with the BBB-AA spread narrowing from 0.97% to 0.85%, indicating improving credit conditions and reduced risk premiums in corporate bonds.
Commodities: Inflation Hedge Strengthening
Both gold and oil projections have strengthened:
- Gold: Expected returns increased from 6.22% to 6.78% (R-squared 0.72)
- Oil: Expected returns rose from 4.06% to 4.65%
These increases, combined with the declining dollar (Trade Weighted Dollar at -1.76%), suggest our models are pricing in persistent inflation concerns and potential dollar weakness over the next decade.
What This Means for Investors
The implications of these shifts are profound:
1. Home bias has become extraordinarily expensive. U.S. investors maintaining heavy North American equity overweights are accepting dramatically lower expected returns—potentially sacrificing 5-7% annually compared to developed international alternatives.
2. Geographic diversification has moved from optional to essential. The dispersion in expected returns across regions is now wide enough that allocation decisions will likely be the primary driver of portfolio performance over the next decade.
3. Factor investing deserves renewed attention. The small cap growth opportunity identified by our models represents a tactical overlay that could meaningfully enhance returns, particularly for investors willing to tolerate additional volatility.
4. The yield curve tells a story of transition. The inverted short-to-intermediate curve suggests near-term economic uncertainty, while elevated long-term rates indicate markets expect sustained nominal growth (or inflation) over the decade ahead.
5. Commodities warrant consideration. With expected returns of 6-7% and negative dollar correlation, gold in particular offers both return potential and portfolio diversification benefits.
Lessons from 2000: Navigating Bubbles Without Calling Tops
I lived through the 2000 tech crash, and it taught me an invaluable lesson: betting against a bubble can be just as dangerous as riding it too long. Financial bubbles have a stubborn tendency to inflate higher and persist longer than anyone expects, and calling a market top is a fool's game.
Many experts were already declaring the tech bubble in 1999, a full year or more before it actually burst. Those who positioned defensively too early watched in frustration as the market continued its ascent, leaving them behind. As John Maynard Keynes famously observed, "markets can remain irrational longer than you can remain liquid."
What I remember most clearly from 2000 wasn't the valuation models finally making sense—it was the frauds. When WorldCom and Enron unraveled, that's when we knew something fundamental had broken. The frauds weren't the cause of the crash; they were the symptom that emerged when the music finally stopped and everyone could see who'd been swimming naked.
A Practical Framework for Today
Given our models' projections and the lessons of history, here's how investors should respond to today's elevated U.S. equity valuations:
1. Focus on appropriate long-term asset allocations. This isn't about market timing—it's about ensuring you're not overexposed to the most expensive markets while ignoring compelling opportunities elsewhere.
2. Diversify internationally with conviction. The data supports meaningful allocations to Developed Asia, Europe, and selectively to Emerging Markets. These aren't speculative bets—they're positioning for where the return potential actually lies.
3. Don't abandon U.S. equities entirely. Even in expensive markets, there are pockets of value. Small cap growth stocks, for instance, offer a compelling opportunity within the U.S. market.
4. Maintain risk discipline. Use proper analytics and scenario analysis to understand how your portfolio behaves under different market conditions. The next decade will likely look very different from the last one.