Midyear insights: Opportunities amid globalization’s discontents

• Dina Ting
  Head of Global Index Portfolio Management
  Franklin Templeton

Market returns of major economies (year to date, as of June 2, 2025)¹

Diversification vs. tariff sensitivity

Based on lessons learned from the Russia-Ukraine war, the UK has recently unveiled plans to significantly increase defense spending and accelerate the development of next-generation security capabilities. The notable increase follows the global trend in military spending, which reached USD 2.7 trillion last year – a real growth of USD 1.5 trillion. USD last year – a real growth of 9.4% compared to 2023.²We believe this localization of defense production should further boost job growth and revitalize smaller industrial hubs.

The South Korean market is also getting a boost as aerospace and defense companies have recently gained due to global expansion efforts and expectations of increasing orders as a result of higher European defense spending. A leading aerospace company from South Korea has formalized its plan to establish a production facility in Germany and pursue other projects in Poland, Romania and Canada to strengthen its leading position in the sector.

In the current year, net inflows into exchange-traded funds (ETFs) in South Korea grew by more than 121%²– more than any other major Asian economy in this period. With a return of 21.3% as measured by the KOSPI index (compared to 1.1% for the S&P 500 index), the country has also outperformed the US market year-to-date.³We are optimistic that the landslide election victory of new South Korean President Lee Jae-myung can usher in a long-awaited political normalization in Seoul after the months-long political crisis triggered by the impeachment of the former head of state in December.

Eurozone/Germany

For the second half of the year, we continue to see opportunities in Germany and the eurozone, which offer a differentiated sector allocation compared to the technology-heavy S&P 500 Index. In contrast, the information technology (IT) sector is the third largest in Germany. Also in the Stoxx Europe 600 Index, the highest weightings are in financials (around 23%) and industrials (around 19%), while IT makes up only 7% of the index.⁴The European equity market saw an early surge in March when German government officials proposed spending hundreds of billions of euros on infrastructure and defense – a notable departure from Berlin’s reputation as a frugal budget authority. The Stoxx 600 Index outperformed the S&P 500 by around 20 percentage points in US dollar (USD) terms at the end of May, a significant turnaround for the long-sluggish market.

In addition, the US government is considering taxing foreign holders of US assets from countries with “unfair” tax practices – a move that could slow capital inflows and weaken the USD. This is prompting investors to reassess their dollar exposure, especially after the simultaneous sell-off in US equities, bonds and USD in April, which showed less diversification benefits. We believe the region is increasingly attractive given a stronger euro, robust corporate earnings and attractive valuations, which is drawing investors’ attention back to the eurozone.

So far this year, ETFs focused on Europe have seen net inflows of USD 33 billion, bringing total net inflows to USD 238.97 billion.⁵Net inflows into ETFs are up 19% year to date. We expect the upcoming NATO summit to shed more light on planned defense spending and are optimistic that the associated tax reforms can further boost growth. According to some estimates, Germany’s proposed infrastructure spending alone could boost economic output by more than two percentage points per year over the next ten years.

These comprehensive reforms will benefit not only the defense sector, but the entire economy by boosting job growth and key development areas such as manufacturing, environmental technologies and digital infrastructure.

The “giants” of Latin America: Mexico and Brazil

Notwithstanding the current uncertainty over tariffs faced by the steel industry on its exports to the US, we believe Mexico should continue to benefit as it accounts for a disproportionate share of nearshoring opportunities.

It remains to be seen whether President Trump can enforce his tariff policy in court – the steel tariffs for Brazil and Mexico pose significant risks in our view. Mexico is also grappling with a significant decline in remittances (a key component of the Mexican economy), which recently posted the steepest annual drop in more than a decade as US lawmakers consider taxing remittances and continue to crack down on immigration.

Last year, Mexico received nearly $65 billion in remittances, equivalent to about 3.5% of its gross domestic product (GDP). A continued decline could affect consumption in Latin America’s second largest economy. However, the Mexican equity market is heavily weighted towards sectors such as consumer staples and communication services, which are known for their stable cash flows and reliable dividends and offer some resilience in uncertain times. According to our analysis, valuations also appear attractive compared to historical averages: over the last five years, the average twelve-month adjusted price-to-earnings ratio of Mexican equities has been around 19x. Currently, the S&P/BMV Total Mexico Index trades at a P/E ratio of 12.6x based on projected earnings^(6).

Brazil

As companies continue to shift to a “China plus” strategy, i.e. maintaining operations in China while expanding production in other countries, we believe Brazil could also benefit. China, Brazil’s largest trading partner, is already continuing to shift its demand for agricultural goods to Brazil, which is the least directly affected in the tariff war as it bears the lowest reciprocal US tariffs.

President Luiz Inácio Lula da Silva’s (Lula) recent visit to Beijing resulted in planned investments and agreements worth around USD 4.8 billion – underlining Brazil’s growing economic ties with China. Despite the current fiscal challenges, we believe that Brazil’s strategic positioning as a major commodity exporter, particularly of soybeans and meat, provides a good basis for the country’s economic growth. In the second half of the year, politics are likely to weigh more heavily on the Brazilian market as the presidential elections next year come into sharper focus. Given Lula’s low approval ratings, his health problems (emergency brain surgery and chemotherapy) and his age (81), there is speculation that new candidates could emerge. This increases the potential for markets to react positively to signs of change. We will be keeping a close eye on the divergences between countries and the specifics of the region in the near term as they highlight the different opportunities and risks – especially in light of Trump’s approach to reciprocal policies – and underscore the need for more nuanced investment strategies.

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Footnotes:

1. Source: Bloomberg, measured in US dollars. Germany – DAX = The DAX is a stock market index composed of the 40 largest German blue-chip companies traded on the Frankfurt Stock Exchange. It is a total return index. The prices are taken from the Xetra trading platform. Mexico – MEXBOL = The S&P/BMV IPC (MEXBOL) aims to measure the performance of the largest and most liquid stocks listed on the Bolsa Mexicana de Valores. The index is designed to be a broad, representative and yet easily replicable index for the Mexican equity market. Subject to diversification requirements, constituents are weighted by modified market capitalization. Eurozone – EURO STOXX 50 = The EURO STOXX 50 is an index for eurozone equities developed by STOXX, an index provider belonging to Deutsche Börse Group. The index is made up of 50 shares from eleven eurozone countries. The EURO STOXX 50 represents the blue-chip companies in the eurozone that are considered leaders in their respective sectors. Brazil – BOVESPA = The Bovespa index, better known as Ibovespa, is the benchmark index for some 86 stocks traded on the Brazilian stock exchange and over-the-counter market, which account for the majority of trading and market capitalization on the Brazilian stock market. It is a weighted index. South Korea – KOSPI = The Korea Composite Stock Price Index (KOSPI) is the index of all common stocks traded on the Stock Market Division (formerly Korea Stock Exchange) of the Korean Stock Exchange. USA – S&P 500 Index. Indices are not actively managed and it is not possible to invest directly in an index. Fees, costs or sales charges are not included in the indices. Past performance is not an indicator of future returns. Further information on the data provider can be found at www.franklintempletondatasources.com.
2. Source: “Unprecedented rise in global military expenditure as European and Middle East spending surges.” Stockholm International Peace Research Institute. April 28, 2025.
3. Source: Bloomberg, as of June 3, 2025.
4. Source: Bloomberg, yields as of May 31, 2025. Global net capital flows as of June 2, 2025. The Korea Composite Stock Price Index (KOSPI) is the index of all common stocks traded on the Stock Market Division (formerly Korea Stock Exchange) of the Korea Stock Exchange. Indices are not actively managed and it is not possible to invest directly in an index. Fees, costs or front-end loads are not included in the indices. Past performance is not an indicator of future returns. Further information on the data provider can be found at www.franklintempletondatasources.com.
5. Source: Bloomberg, as of June 4, 2025 The STOXX Europe 600 – also known as STOXX 600, SXXP – is an index for European equities created by STOXX Ltd. Indices are not actively managed and it is not possible to invest directly in an index. Fees, costs or front-end loads are not included in indices. Past performance is not an indicator of future returns.Further information on the data provider can be found at www.franklintempletondatasources.com.
6. Source: Bloomberg, as of June 3, 2025.
7. Source: Bloomberg, as of June 3, 2025, based on the adjusted P/E ratio for the S&P/BMV Total Mexico Index. The S&P/BMV Total Mexico Index is intended to serve as a broad benchmark for the Mexican equity market. Indices are not actively managed and it is not possible to invest directly in an index. Fees, costs or front-end loads are not included in the indices. Past performance is not an indicator of future returns. Further information on the data provider can be found at www.franklintempletondatasources.com.