At the start of this year, we examined whether the long run of U.S. exceptionalism could endure as the primary investment story for 2025. Thus far, that theme has held true — though not in the way many anticipated. April’s tariff surprise, souring U.S. consumer sentiment, and sticky inflation all contributed to U.S. stocks trailing their ex-U.S. counterparts by an historic gap.
At the same time, the U.S. AI leaders were dealt another surprise with the emergence of China’s low-cost DeepSeek model, demonstrating that breakthrough innovation need not be confined to big-budget U.S. firms and their hyperscale strategy. The AI incumbents nevertheless continued to boost capital spending on their data-center infrastructure.
This quarter’s Markets in Focus explores how global markets reacted to trade tensions, AI breakthroughs and why capital allocation may be a pivotal risk factor in the AI arms race.
European and EM stocks in the lead
U.S. equities, anchored by mega-cap names, underperformed international stocks year-to-date through the first week of April by one of the widest margins since the 2008 global financial crisis. They lagged bonds by a substantial gap as well. From a factor perspective, sharp declines in momentum and beta in the U.S. signaled a shift in risk appetite not seen since the start of the COVID-19 pandemic, five years ago.
The early 2025 narrative: US stocks and dollar stumble
Meanwhile, EM — supported by rallies in China, Korea and Mexico — recouped some of their post-U.S. election underperformance relative to developed market (DM) stocks. China’s gains were narrowly concentrated among AI-linked names benefiting from DeepSeek’s debut. In contrast, Europe’s performance was more broad-based. Dollar weakness further boosted overseas equity gains for U.S. investors, most notably in Europe.
European equities rise despite tech and trade uncertainty
Revisiting empire building and capital allocation in the AI era
Although AI firms led the recent U.S. equity downturn, they also led in their investment spend since 2021. By our calculations, these companies accounted for over 10% of global capital expenditures and nearly 40% of global R&D outlays last year. Importantly, this spending grew 60% faster than that of non-AI peers in both the U.S. and EM, and at nearly quadruple the pace of firms in the MSCI World ex-USA Index. Also notable is that these firms invested at a faster rate than their revenue growth.
DeepSeek’s emergence highlighted wide divergence in corporate spending
Forty years ago, the late Michael Jensen’s influential work on empire building sparked debate on whether aggressive capital spending and acquisitions always served shareholders’ interests.[1] Today’s rise in AI capex has revived this conversation for investors.
Evidence suggests measured spending — part of a broader investment-quality approach — plays a meaningful role in long-term stock returns. The investment-quality factor in MSCI’s equity risk models differentiates companies with modest asset expansion, capital spending and share issuance from those that may be overextending.
DeepSeek and the deep history of investment quality
The factor’s deep history in the U.S. aligns with Jensen’s conclusions. Conservative allocators have outperformed more aggressive peers across the U.S., Europe and EM, although the effect was more muted in Japan. This weaker signal may be attributed to Japanese companies’ longstanding pattern of corporate spending and cross-shareholdings. Corporate governance reforms introduced in 2021, however, appear to have begun reversing this dynamic.
Conservative capital allocators outpaced more aggressive spenders
Breaking down the individual components of investment quality reveals a consistent pattern: Firms with slower capex growth, limited asset expansion and lower net share issuance have outperformed peers lacking these attributes.[2] This trend holds across regions, though the reward for conservative capex is most pronounced in the U. S.
For U.S. AI incumbents, the steer of history is clear: Rapid capex growth raises concerns of overinvestment, even though most have financed their expansion with free cash flow rather than dilutive share issuances.
Risks of capex overinvestment extended globally
Tariffs and technology collide to start 2025
Tariff threats and shifting U.S. policy have already unsettled markets in early 2025, with America’s AI incumbents bearing much of the brunt. Rising capital costs and the emergence of lower-cost competitors could further undercut the advantage of the firms that fueled global equity returns over the past three years. Given the cyclical nature of corporate spending, the risk of overinvestment looms large, echoing the lessons of Jensen’s work four decades after publication.
The authors would like to thank Santosh Panda for his contributions to this research.