Skip to content

CONTRIBUTORS

Chris Galipeau

Senior Market Strategist
Franklin Templeton Institute

Lukasz Kalwak, CFA

Market Strategist
Franklin Templeton Institute

Overview

  • Despite the solid gains in global equity indexes in 2025, we still believe conditions remain favorable for the rotational bull market to continue.
  • We expect real US gross domestic product (GDP) to grow at 2.5% with moderating inflation, ongoing Federal Reserve (Fed) interest-rate cuts, a robust fiscal impulse and a broad-based earnings recovery to drive further equity gains over our tactical horizon. With the Fed likely to ease, monetary easing may continue in many emerging markets as well. 
  • We think market leadership will continue to broaden and that two often-overlooked equity market segments are poised to outperform: US small caps and emerging markets (EMs).

This paper serves as a sequel to three research papers we published beginning in January 2025 and offers a potential road map for investors seeking opportunities in 2026. We will discuss the following:

  • Market broadening—revisiting our January 2025 theme
  • What’s ahead—potential for an earnings-driven bull market
  • Why small caps may shine
  • International opportunities are still compelling, with EMs poised to lead
     

Conclusion

With the US economy showing strong growth and the Fed resuming its interest rate-cutting cycle in 2025, the environment looks increasingly favorable for corporate earnings to expand. It may be an opportune time to consider increasing allocations to equities, as our research indicates they are poised for potential further gains.

Our research themes in 2025 emphasized the likelihood for equity market performance to broaden beyond the Magnificent Seven.1 As we have entered 2026, our analysis of the capital markets continues to favor the likelihood of broadening performance. Here, we highlight two areas of equity markets that may be especially attractive—US small caps and emerging markets. Investors often avoid these areas of the market, but we believe they should instead take a closer look.

The recent struggles of small-cap companies can be attributed primarily to their vulnerability to rising interest rates, which significantly increased borrowing costs and pressured their profitability. However, with interest rates now at lower levels and perhaps more rate cuts ahead, the outlook for small caps is becoming increasingly favorable.

As a result, this rate-sensitive asset class may experience a notable resurgence in performance. Our research finds valuations attractive on an historical basis, adding a potential tailwind to performance.

EMs are also becoming more attractive. Easing global monetary conditions should make local funding cheaper for EM companies, while also improving currency dynamics. Our research shows EM equities are currently undervalued relative to developed markets, offering what we consider significant upside potential as global financial conditions stabilize and growth prospects improve. We believe companies in EMs that are projected to deliver stronger earnings growth than their counterparts in the United States, Europe and Japan, now may be an opportune time to consider increasing exposure to this asset class.

Endnote

  1. The Magnificent Seven refers to Apple, Microsoft, Amazon, Alphabet (Google), Tesla, Nvidia and Meta.

 

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Diversification does not guarantee a profit or protect against a loss.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Large-capitalization stocks may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

WF: 8421864

Copyright ©2025. Franklin Templeton. All rights reserved.

This document is intended to be of general interest only. This document should not be construed as individual investment advice or offer or solicitation to buy, sell or hold any shares of fund. The information provided for any individual security mentioned is not a sufficient basis upon which to make an investment decision. Investments involves risks. Value of investments may go up as well as down and past performance is not an indicator or a guarantee of future performance. The investment returns are calculated on NAV to NAV basis, taking into account of reinvestments and capital gain or loss. The investment returns are denominated in stated currency, which may be a foreign currency other than USD and HKD (“other foreign currency”). US/HK dollar-based investors are therefore exposed to fluctuations in the US/HK dollar / other foreign currency exchange rate. Please refer to the offering documents for further details, including the risk factors.

The data, comments, opinions, estimates and other information contained herein may be subject to change without notice. There is no guarantee that an investment product will meet its objective and any forecasts expressed will be realized. Performance may also be affected by currency fluctuations. Reduced liquidity may have a negative impact on the price of the assets. Currency fluctuations may affect the value of overseas investments. Where an investment product invests in emerging markets, the risks can be greater than in developed markets. Where an investment product invests in derivative instruments, this entails specific risks that may increase the risk profile of the investment product. Where an investment product invests in a specific sector or geographical area, the returns may be more volatile than a more diversified investment product. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from use of this document or any comment, opinion or estimate herein. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

Any share class with “(Hedged)” in its name will attempt to hedge the currency risk between the base currency of the Fund and the currency of the share class, although there can be no guarantee that it will be successful in doing so. In some cases, investors may be subject to additional risks.

Please contact your financial advisor if you are in doubt of any information contained herein.

For UCITS funds only: In addition, a summary of investor rights is available from here. The fund(s)/ sub-fund(s) are notified for marketing in various regions under the UCITS Directive. The fund(s)/ sub-fund(s) can terminate such notifications for any share class and/or sub-fund at any time by using the process contained in Article 93a of the UCITS Directive.

For AIFMD funds only: In addition, a summary of investor rights is available from here. The fund(s)/ sub-fund(s) are notified for marketing in various regions under the AIFMD Directive. The fund(s)/ sub-fund(s) can terminate such notifications for any share class and/or sub-fund at any time by using the process contained in Article 32a of the AIFMD Directive.

For the avoidance of doubt, if you make a decision to invest, you will be buying units/shares in the fund(s)/ sub-fund(s) and will not be investing directly in the underlying assets of the fund(s)/ sub-fund(s).

This document is issued by Franklin Templeton Investments (Asia) Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.

Unless stated otherwise, all information is as of the date stated above. Source: Franklin Templeton.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.