Why Overweighting US Equities Might Be Risky in 2025: Nomura’s Cautionary Take

The U.S. equity market’s recent streak of gains—26% in 2023 and 23% in 2024—has left valuations elevated, sparking a critical debate about whether investors should continue piling into U.S. stocks. According to Nomura analysts Gareth Nicholson and Ross French, the answer is a resounding “no.” In a recent analysis, they argue that maintaining an “overweight” exposure to U.S. equities heading into 2025 is a precarious bet, urging investors to diversify into international assets and adopt defensive strategies. Their warnings, rooted in geopolitical risks, valuation extremes, and historical market patterns, underscore a growing divide between optimism and caution in the investment community.

The Fragility of U.S. Market Optimism

Nicholson, a senior strategist at Nomura, highlights two key vulnerabilities in the U.S. market narrative: unresolved U.S.-China trade tensions and the fragility of investor sentiment. While recent diplomatic gestures between the two nations have provided temporary relief, Nicholson argues that systemic issues—from technology restrictions to currency wars—remain unresolved. This uncertainty, he says, could trigger rapid market reversals, especially as investors have grown complacent in the face of consecutive years of gains.

Valuation Concerns and the Case for Quality

Ross French, a quantitative strategist, takes a deeper dive into the structural risks of U.S. equities. He points to the S&P 500’s current valuation, which sits at a premium to historical averages, and argues that the market’s reliance on a narrow set of high-flying sectors—particularly tech—has created vulnerabilities. French emphasizes a long-standing divide between “quality” and “junk” stocks: the former, defined by low debt, high profitability, and stable cash flows, and the latter, characterized by high leverage and weak fundamentals.

The data is stark. As of late 2024, the P/E ratio of “junk” stocks—those with poor balance sheets and profitability—stands at 32, compared to 24 for quality stocks. This gap, French notes, has historically been a harbinger of risk. Since 2000, in every bear market, quality stocks have outperformed their junk counterparts by an average of 15 percentage points. “When valuations are stretched and the market is vulnerable, quality acts as a shield,” he says.

Why Sector-Neutral Hedging Matters

French’s proposed solution—long-short equity quality strategies—aims to exploit this valuation disparity while minimizing sector-specific risks. These strategies involve taking long positions in high-quality stocks and short positions in their junky counterparts within the same sector. This approach avoids overexposure to sectors like tech or consumer discretionary, which have driven much of the S&P’s gains but also face regulatory and macroeconomic headwinds.

The historical track record is compelling. In the 2020 pandemic crash, for instance, quality stocks fell by 20%—but junk stocks plummeted 35%. Similarly, during the 2008 financial crisis, the spread between quality and junk stocks widened by 40%. French argues that such patterns are likely to repeat in 2025 if valuations fail to correct organically.

The 2025 Crossroads: Crisis or Gradual Adjustment?

Nomura’s analysis hinges on two scenarios for the coming year. In the first, a “black swan” event—such as a sharp escalation in U.S.-China tensions, a geopolitical shock, or a domestic policy misstep—triggers a sharp correction, narrowing the valuation gap through crisis-driven selling. In the second, the market gradually revalues, with investors rotating into undervalued quality names and away from overhyped sectors.

French is skeptical of the latter scenario. “Valuations are too stretched for a soft landing,” he says. “The last time the S&P 500 was this overvalued relative to quality stocks was in 2000, and we all know how that ended.”

Conclusion: Caution, Diversification, and Quality Are the New Norm

The message from Nomura is clear: betting big on U.S. equities in 2025 carries outsized risks. With geopolitical tensions simmering and valuations at precarious levels, investors would be wise to diversify into international markets and adopt hedging strategies that prioritize quality.

The data reinforces this outlook. The S&P 500’s 26% gain in 2023 and 23% in 2024 have pushed its P/E to 28—well above its 20-year average of 17. Meanwhile, the 8-point P/E spread between quality and junk stocks is near its widest in two decades, suggesting a correction could be severe.

For investors, the path forward is twofold: reduce concentrated U.S. exposure and lean into quality-focused, sector-neutral strategies. As Nicholson warns, “The market’s current euphoria may feel safe, but history shows that overconfidence is the first step toward a fall.”

In 2025, prudence—not momentum—will likely be the winning strategy.