Equity ETF Outlook Q4: Seeing fundamentals through the noise
Investors face resilient but uneven growth, renewed inflation pressures and elevated geopolitical uncertainty. This backdrop may create opportunities in US and emerging market equities, supported by structural growth, positive earnings momentum and reasonable valuations. Meanwhile, quality dividend strategies may offer more defensively focused investors income, resilience and diversification from concentrated market leadership.
The US economy remains firmly on an upward growth path, with GDP projected to increase by 2.2% in both 2026 and 2027, compared with 1.1% and 1.3% for Western Europe and 0.8% in both years for Japan.1 Although midterm elections may generate headline volatility, we believe investors should look through the headline noise and focus on long-term fundamentals: the US is at the forefront of the AI revolution while geopolitical instability is less of an economic headwind than in Europe. This economic momentum is visible in expanding manufacturing and services Purchasing Managers’ Indices (PMIs) (Figure 1).
US economic exceptionalism has continued to translate into robust earnings growth, which is no longer limited to mega-cap stocks. Consensus forecasts point to 2026 earnings growth of 32% for the S&P 500, 27% for the S&P MidCap 400, and 41% for the Russell 2000. 2 Notably, the strength of the US outlook may not be fully reflected in valuations, at least on a relative basis, with the S&P 500 Index’s 30% one-year forward price-to-earnings (P/E) premium to MSCI Europe standing close to a five-year low (Figure 2).
While the AI investment cycle is supporting the US economy,3 its domestic impact remains uneven. Consumers remain resilient, but confidence is far from euphoric, perhaps reflecting the K-shaped nature of the economy. Within the technology ecosystem, semiconductor companies continue to benefit from strong demand, while hyperscalers face growing scrutiny around the risk of overspending.
More broadly, the rise in bond yields has increased investor focus on current earnings, cash flows and valuation discipline, reducing tolerance for highly valued companies whose investment case depends primarily on future growth expectations. At the same time, stepping away from sectors with structural growth potential could carry a significant opportunity cost.
In this environment, a sector-neutral value approach may allow access to the US growth engine at less expensive multiples. The MSCI USA Value Exposure Select Index has so far this year outperformed both the MSCI USA Index and the MSCI USA Value Index, which is not sector neutral, while still trading at a lower forward P/E than either (see Figure 3).
The divergence between a resilient US economy and slower growth in Europe may create a favourable backdrop for domestically focused exposures, not least as private investment is projected to rise by 4.1% in 2026 and 4.4% in 2027, 4 potentially benefitting US companies with predominantly domestic revenues. At the same time, elevated inflation, higher yields and geopolitical uncertainty may all challenge corporate resilience and therefore reinforce the case for quality and value tilts.
Against this backdrop, the S&P MidCap 400 Index may offer a combination of domestic bias, with constituents deriving 72%5 of their revenue from within the US; cyclicality, with Industrials representing 24% of the index;6 and relatively undemanding valuations, with a one-year forward P/E of 16.3x.7 US mid-caps share some features typically associated with small caps, including sensitivity to domestic growth, while potentially offering a stronger quality profile, supported by their larger size and the positive-earnings test S&P Dow Jones Indices applies when adding companies.
US economic strength can also benefit small caps but, given the K-shaped economy, and potential further interest rate increases, investors may lean towards active solutions or exposures which emphasise lower valuation multiples
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The gap between the US and other developed markets, in both economic growth and the gains from AI, has been widening. Emerging market (EM) equities may offer a route to diversify geographically away from the US, while retaining access to the AI value chain and faster-growing economies.
High oil prices, Federal Reserve (Fed) policy tightening, and geopolitical uncertainty have been headwinds for emerging markets. Nevertheless, EM equities have outperformed developed markets in 2025 and so far in 2026, although this year’s gains have been concentrated in South Korean and Taiwanese technology stocks.8
Importantly, EM performance has been supported by earnings growth, which is expected to outpace developed markets again in 2027.9 As earnings expectations have risen faster than share prices, valuations have compressed: EM equities trade at 9.6x forward earnings, a ten-year low and a 46% discount to developed markets.10
Although AI-related gains in emerging markets have thus far been concentrated, there is potential for broader participation.
Taiwan and South Korea may continue to benefit from their central role in the semiconductor supply chain. Although the industry tends to be cyclical, the AI expansion may prove more durable than previous cycles, as AI infrastructure requires regular upgrades and replacement to meet rising computing demand.
China is competing directly with the US for AI leadership, reinforcing the position of its domestic technology leaders. Chinese hyperscalers share some of the challenges facing their US peers, including high capital intensity and pressure on free cash flow. Cost-efficient AI models offer competitive potential, although governance and regulatory risks remain material.
India represents the third pillar through its large software and IT services industry. Although it has been a more limited beneficiary of the AI rally, broader adoption could support demand for IT services and enhance the capabilities of software companies over the medium term.
Beyond AI, EM equities also provide access to some of the world’s fastest-growing economies, supporting corporate earnings beyond the technology theme. As Figure 5 sets out, much of the EM growth advantage is concentrated in Asia, with India expected to expand by approximately 7% a year through 2028. China is slowing but continues to grow faster than most developed economies, including the US. Meanwhile, some Latin American and Middle Eastern markets, as well as South Africa, provide commodity exposure that may act as a diversifier versus Asian markets, which are generally net importers of oil and other raw materials.
The MSCI Emerging Markets Index captures approximately 85% of the EM opportunity set11 but excludes small-cap companies, which can complement large- and mid-cap exposure. The MSCI Emerging Markets Small Cap Index provides a distinct country mix: China represents just 9% of the index, compared with 20% of the MSCI Emerging Markets Index, while India accounts for 21% versus 11%.12
EM small-cap companies are also less concentrated. The top 10 holdings account for 6% of the index, compared with 38% for the MSCI Emerging Markets Index, while Information Technology represents 25% versus 44%.13 This broader composition may be particularly relevant following the narrowly driven tech rally.
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The global equity rally has been underpinned by earnings growth, limiting the extent of price-to-earnings multiples expansion. However, companies have reinvested much of those earnings, notably in AI-related capital expenditure, rather than paying them out as dividends. With share prices also rising, dividend yields on market-cap-weighted indices have compressed. At the same time, bond yields have risen, making equity dividend yields less favourable relative to bonds. Capital appreciation, rather than dividends, has been the primary driver of returns over the past two years.14
Investors seeking income might therefore look towards dividend-paying companies. However, in an environment of uneven economic growth and persistent inflation pressures, focusing solely on dividend yield may lead to value traps. This highlights the importance of complementing income generation with a quality screen
Global Dividend Aristocrats aim to offer a yield premium to broad market-cap-weighted indices, and a degree of defensive resilience by requiring companies to have maintained or increased dividends for at least ten consecutive years. This screen favours established businesses and may reduce exposure to distressed companies.
Dividend-paying companies tend to be concentrated in “old economy” sectors and may therefore offer less exposure to AI-related growth. That can also be a benefit: Information Technology makes up around 1% of the Global Dividend Aristocrats index, compared with 33% of the MSCI ACWI, which may appeal to investors seeking diversification away from AI-driven market dynamics (see Figure 7).
These defensive characteristics may be particularly relevant in Europe, where inflation pressures coincide with relatively weak growth. The S&P Euro High Yield Dividend Aristocrats Index’s 10-year dividend requirement produces overweights to defensive industries such as Insurance and Utilities, and underweights to Banks and Semiconductors relative to the MSCI Economic and Monetary Union (EMU) Index.15
The index has a higher estimated dividend yield, at 5.1% versus 3.3% for the MSCI EMU, and trades at a lower one-year forward P/E, at 11.3x compared with 14.6x (see Figure 8). While the value appeal of market-cap-weighted European benchmarks has diminished relative to the US (see Figure 2), it remains evident in Euro Dividend Aristocrats.
As we expect inflation and geopolitical uncertainty to persist, investors seeking an alternative to AI-led growth may consider strategies combining income, quality and diversification.
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