After a strong start to 2025 in 1Q and then a 6-month pause in 2025, global reallocation should be a recurring tailwind in 2026 and beyond.
After much anticipation – and despite significant trade policy uncertainty – international equities had a spectacular 2025. As of the time of writing, international equities are up 31% in U.S. dollar terms, outperforming U.S. equities by 1,520bps (the biggest outperformance since 1993) and including every major region. An improvement in sentiment from a low base has been behind the outsized moves: Multiple expansion has contributed 15%pts to returns and a weaker U.S. dollar has contributed another 7%pts. This has been particularly powerful for markets that had previously underperformed, including parts of emerging markets (Korea and LATAM) and the eurozone. It has not all been based on hopes and dreams, however, as next twelve months earnings expectations moved higher in all the major regions (except LATAM). This was due to more resilient global economic and earnings growth than feared despite tariff-related uncertainty and stronger currencies.
Next year, sentiment should still support international equities given low positioning albeit at a lower contribution. After a strong start to 2025 in 1Q and then a 6-month pause in 2025, global reallocation should be a recurring tailwind in 2026 and beyond. Inflows into emerging markets have begun to inflect higher after muted interest the last few years. As noted in our Mid-Year Outlook, there’s a push and pull driving global investors to invest their next marginal dollar outside the United States:
- U.S. dollar is still 10% overvalued versus fair value3
- This year’s positive correlation between the dollar and U.S. equities is leading foreign investors to hedge more dollar exposure
- U.S. equity premium over international equities is still at 34% (versus its 19% long-run average)
- U.S. still represents over 65% of global equity benchmarks
- U.S. equities still have a record over 40% concentration in 10 companies (and in the AI theme)
In 2026, the biggest contributor to international equity returns should come from the fundamentals side, especially earnings growth. In 2025, investors had some disappointment with low-single-digit earnings growth in Europe and Japan (versus over 10% in the United States) due to higher tariffs and stronger currencies hitting key export companies. Next year, expectations are for a narrowing in earnings growth between the United States and other regions, with about 10% expected. This looks reasonable given resilient global activity, less tariff uncertainty, easier global monetary policy given well-behaved inflation, fewer unexpected swings in currencies and a manufacturing upturn in Germany and broader Europe as recent government investments are executed.
In fact, despite a stall in 2025, the earnings gap between U.S. and international companies has been shrinking since the pandemic (except for China), as Exhibit 4 shows. Looking ahead, it’s structural versus cyclical themes that give us conviction in international earnings. These include four major themes that are difficult PASS on.
- Positive nominal growth: The shift to higher nominal growth and the end of negative rates has transformed European and Japanese companies, especially banks and value sectors. Opportunity still exists in developed ex-U.S. financials given still deep valuation discounts.
- AI theme broadening: This theme should continue next year involving a broader range of semiconductor, cloud/internet and robotics companies. This supports technology sectors in Offshore China, Korea, Taiwan and Japan, and is increasingly important in emerging markets, where technology is 27% of the index.
- Spending on the fiscal side: Unlike the post-GFC and pre-pandemic cycle, this cycle has seen strong global government investment, with the eurozone leading (Exhibit 5). 2025 saw several big fiscal announcements, the biggest of them all in Germany, but also broader European countries pledging to spend 5% of GDP on defense and infrastructure. This spending should start to occur in 2026 – especially on domestic procurement benefiting European defense champions (still trading at a discount to U.S. peers). Japan’s new government is also likely to boost fiscal spending, especially aimed at households. That, combined with accelerating real wage growth, should provide a welcomed further reflationary boost. In developed markets ex-U.S., this argues for a tilt toward domestic companies, including down the market cap spectrum.
- Shareholder focus overseas: Buybacks and shareholder-friendly policies, once unique to the United States, have spread to Europe and Asia. In 2025, buyback announcements as a share of market cap in Korea and Japan surpassed the United States. This trend, especially in Japan and Korea, supports value stocks and boosts earnings per share. International markets also offer dividend yields twice those of the United States.