This year’s unsettling macro events have reinforced diversification as a critical tool for managing volatility while still capturing thematic opportunities. In 2025, diversification proved essential as U.S. policy upheaval drove a rotation out of domestic assets and toward international markets, particularly those underpinned by supportive domestic policies and improving growth outlooks.
This year, however, investors have gravitated back to the U.S., as the energy shock highlighted relative resilience at home while reinforcing structural advantages in areas like AI.
Still, the S&P 500’s concentration remains a concern. Technology now accounts for nearly 40% of the index, leaving investors exposed if expectations for hyperscaler spending begin to soften. Moreover, given the global nature of tech supply chains, any slowdown in U.S. AI investment would likely have meaningful spillovers into regions whose earnings are closely tied to the AI cycle.
As a result, diversification is becoming increasingly difficult to achieve. Shared exposure to AI and global energy dynamics are reducing regional differentiation, forcing investors to reassess where true diversification can still be found.
South Korea and Taiwan are among the regions most exposed to the Middle East conflict, as a meaningful share of their crude oil and natural gas imports transits the Strait of Hormuz. Even so, the macro impact on those economies has been less severe than initially feared, enabling markets to sharply rebound following the initial March selloffs. Returns in the MSCI South Korea and Taiwan equity indices are now at roughly 117% and 63% year-to-date in USD terms, respectively, as of June 1.
While policy measures, such as electricity price freezes and fuel price caps, have helped cushion households and corporations from the energy shock, a structural force is also underpinning both economies and their equity markets.
Decades of the U.S. offshoring semiconductor production to Korea and Taiwan have positioned both regions at the epicenter of the AI buildout. Multi-year agreements with U.S. hyperscalers, combined with the disproportionate share of key chip producers’ revenues tied to U.S. demand, have created a deep symbiotic relationship between U.S. tech leaders and their Asian suppliers.
With U.S. hyperscaler capex forecasted to reach $700 billion in 2026 and exceed $1 trillion in 2027, semiconductor demand is poised to continue supporting earnings growth in Korea and Taiwan.
However, this strength also limits diversification benefits. Korea and Taiwan now account for nearly half of the MSCI Emerging Markets Index—roughly double their 2020 weight—making the index increasingly sensitive to U.S. tech dynamics. As a result, EM equities have become more correlated with the U.S. AI cycle, diminishing their role as a portfolio diversifier.
Europe has historically offered diversification due to its lower exposure to technology. This became more compelling last year, as a shift from fiscal austerity to expansion supported growth and equity market performance.
However, the region’s outlook has weakened again. As a net energy importer, Europe is particularly vulnerable to energy shocks, and its sensitivity has been evident during the recent U.S.–Iran tensions. Since late February, European equities have underperformed U.S. markets and remain below pre-conflict levels. Given this exposure, Europe has not been perceived as an attractive diversifier from the U.S. AI cycle in recent months.
That said, the outlook for Europe could improve if geopolitical tensions ease. Recent reports suggesting a U.S.–Iran deal may be moving closer could help stabilize energy markets and renew investor interest, particularly given Europe’s longer-term tailwinds in infrastructure and defense.
In contrast to both U.S. AI-linked Asian markets and energy-shock exposed Europe, China stands out as an effective portfolio diversifier given its push to reduce reliance on external partners for both energy supply and critical tech inputs, specifically semiconductors.
Lower vulnerability to the energy shock: China’s long-term effort to diversify its energy mix—through the steady deployment of renewables alongside increased coal-fired electricity capacity—has enabled it to boost crude oil reserves and reduce its sensitivity to global energy shocks. This relative insularity helped keep China’s equity market resilient throughout the March selloff, posting only a modest decline broadly in line with the S&P 500’s pullback.
Lower vulnerability to the U.S. AI cycle: China’s strategic push to strengthen domestic tech supply chains, thereby reducing its reliance on the U.S. and its allies, is fostering a more independent technology ecosystem. Recent developments highlight this shift. DeepSeek’s latest model has been trained on domestically produced semiconductors, underscoring its pivot away from reliance on U.S. advanced chips.
At a time when global markets are increasingly driven by common macro factors, China’s relative independence from both energy shocks and the U.S. AI cycle makes it one of the few major markets offering more distinct diversification benefits.
Against a volatile backdrop, diversification remains investors’ first line of defense. But as energy and technology supply chains become more globally interconnected, regional exposures are increasingly shaped by the same underlying forces, making portfolio diversification harder to achieve in practice.
This is evident across regions. Korea and Taiwan have been buoyed by semiconductor demand but remain exposed to geopolitical risks and shifts in the U.S. tech cycle, contributing to rising concentration within broader EM indices. Europe, while less tied to AI, remains highly sensitive to energy dynamics, which continue to weigh on its near-term outlook—though a potential easing in geopolitical tensions could improve its role as a diversifier. China, by contrast, is becoming more internally driven across both energy and technology, offering a more distinct source of diversification, particularly as valuations remain relatively attractive.
As differentiation across some key regions has diminished, investors face a more complex diversification challenge. Traditional geographic allocations may offer less insulation from volatility, reinforcing the need to reassess where diversification can still be meaningfully achieved in an increasingly interconnected global market.
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