Americans don’t like fruit cake.
This issue comes up every December when Sari, having stolen the job from me, sets about making the family Christmas cake. It is a divine confection - currants, sultanas, cherries, candied peel and almonds, liberally presoaked in whiskey and then folded in with flour, eggs, butter and spices and baked for hours at a low temperature. The scent in the kitchen is intoxicating but temporary as the cake, when cooled, is encased first in almond icing and then in royal icing. It weighs in at a hefty eight pounds and tastes magnificent when I can no longer restrain myself on Christmas Eve or Christmas Morning.
Sari is partial to the icing. However, being born in America, she doesn’t much like the fruit cake itself and so contributes to its slow consumption in a rather unbalanced way.
Americans also generally don’t like international stocks. Nevertheless, last year, international stocks trounced their U.S. counterparts, with the MSCI-ACWI Ex-U.S. posting a 33% total return in U.S. dollars compared to 18% for the S&P500. A lower dollar helped, with currency contributing eight percentage points to the total return. But currency was just the icing on top. Even in local currency terms, the ACWI Ex-U.S. gained 25%.
Looking forward, we expect a falling dollar to continue to boost the return on foreign stocks. But it’s important to look beneath the currency icing and recognize the opportunity in international equities, even denominated in their local currencies. This starts by looking at economic fundamentals, fiscal and monetary policy, the earnings outlook, and valuations. Of course, it’s impossible to do this in a short note for all the important economies and markets in the world. However, the broad themes are discernable in the eurozone, the UK, China and Japan, which, collectively, account for more than 60% of the equity opportunity outside the United States.
Economic Fundamentals and Central Bank Policy
Overall, the global economy is seeing moderate but balanced growth entering 2026. Composite PMI data show December index readings for the euro area, the U.K., China and Japan, all hovering in a narrow band between 51.0 and 51.5.
In the eurozone, the unemployment rate was 6.3% in November, within 0.1% of its lowest monthly reading this century while December inflation, at 1.9% year-over-year, was very close to the ECB’s 2.0% objective. Real GDP appears to have grown at a moderate 1.5% pace in 2025 and it should maintain this pace in 2026, despite trade challenges, reflecting greater fiscal spending, particularly by Germany and particularly focused on defense. In this environment, the ECB is essentially on hold, keeping its deposit facility rate at 2.0% which has been in effect since June of last year.
In the U.K., the economy looks softer with the unemployment rate rising quite quickly to 5.1% last October from 4.3% a year earlier. In addition, while real GDP growth appears to been close to 1.4% in 2025, it is expected to slow in 2026, partly due to fiscal tightening imposed as part of last November’s budget. CPI inflation was 3.2% in November. However, the diversion of cheap Chinese goods from the U.S., some reduction in inflation due to measures introduced in the budget and a softening labor market could combine to cut inflation to 2% by the summer.
In December, the Bank of England voted, on a narrow majority, to cut overnight interest rates from 4% to 3.75%. They still regard this as restrictive and, given the potential for softening in the UK labor market and inflation, futures markets are pricing in two further 25-basis-point cuts for 2026.
After a year of trade turmoil, China reported real GDP growth for 2025 of 5.0%, in line with the government’s targets. This result reflected offsetting tailwinds and headwinds. On the positive side, real exports climbed by 5.5%, despite U.S. tariffs, as China succeeded in reducing the U.S. share of its exports to just 10%, (compared to 20% back in 2017), while increasing its sales to other Asian countries and Europe. In addition, industrial production numbers show strength in high-tech sectors, as China increasingly focuses on areas such as AI and robotics. On the negative side, fixed asset investment fell in 2025 as continued weakness in housing weighed on the construction and infrastructure sectors. More broadly, a plunging birth rate led to the population falling for a fourth consecutive year in 2025 while consumers remain worried about the value of their property assets. All of this is leading consumption to lag production, pushing inflation negative as measured by both the producer price index and the GDP deflator.
In 2026, according to estimates from our investment bank colleagues, China will likely try again to stimulate demand by holding the central government fiscal deficit at 4.0% of GDP. This could cause the general government deficit, including highly indebted local governments, to rise from 10.7% of GDP to 11.1%. This would amount to fiscal stimulus, although these huge deficit numbers, of course, raise serious questions about debt sustainability. Monetary policy changes will likely include only very modest reductions in short-term interest rates and reserve requirements with China’s still massive trade surplus boosting the Yuan relative to the dollar.
The Japanese economy has maintained solid momentum in recent months as the economy has weathered the effect of U.S. tariffs better than expected. Real GDP growth for 2025 may have exceeded 1% despite a 2.3% annualized decline in the third quarter, and should be sustained in 2026, partly due to proposed expansionary fiscal policy under Japan’s new Prime Minister, Sanae Takaichi. Prime Minister Takaichi’s ability to carry this out, however will depend on the success of the Liberal Democratic Party in Diet elections that she has called for February 8th.
Higher inflation is becoming a serious political issue in Japan after decades of stagnant prices, with headline inflation averaging close to 3% since the fall of 2022. Takaichi-san proposes to tackle the inflation problem in part by lowering gasoline taxes and suspending the sales tax on food. However, such measures, if implemented as part of overall fiscal expansion and accompanied by a falling yen, will likely do little to lower underlying inflation.
Takaichi-san would like to pair fiscal expansion with continued monetary ease. However, the Bank of Japan, having raised the overnight rate to 0.75% in December, is expected to raise overnight rates at least once and perhaps twice in 2026. This could be seen as a belated response to rising bond yields – the 10-year JGB yield is currently at 2.18%, up from 1.20% just a year ago.
Earnings, Valuations and Currency Icing
As the fourth-quarter earnings season gets under way, prospects look good for a global convergence in earnings growth. Analysts are expecting year-over-year S&P500 earnings growth of 7.0% for 4Q2025, a number that companies should easily exceed, while earnings growth should be much weaker in Europe and Japan. However, heading into 2026, fiscal stimulus in Japan and Europe should at least match U.S. levels with a narrowing of economic growth differentials. Recent monetary easing and more modest wage gains could allow for an increase in corporate margins in Europe. Overall, according to IBES, analysts expect 2026 EPS growth of 15.5% in the U.S. compared to 12.8% in Europe ex-U.K., 10.6% in the U.K., 11.4% in Japan and 12.6% in China. All of these numbers look too optimistic, given the macro backdrop, but the convergence is notable.
Equally notable, is the continued divergence in valuations. As of January 15th, the S&P500 was trading at a lofty forward P/E ratio of 22.2 times. By contrast, international P/Es were generally in the teens, ranging from 13.6 times for the FTSE 100 to 16.7 times for the Topix. Partly as a consequence, overseas dividend yields are also much higher, ranging from 2.2% in Japan to 3.3% in the U.K. compared to just 1.2% in the U.S.. Even after a great performance year for international stocks, they remain significantly cheaper than their U.S. counterparts.
Solid economic growth, generally low interest rates and a convergence in earnings growth could well allow international stocks to outperform U.S. stocks in 2026 again. And then there is the currency icing.
A common thread across the eurozone, China and Japan is the prospect of fiscal stimulus in 2026. This is also the case in the U.S., as income tax refunds from the OBBBA and possible tariff rebate checks boost consumer spending. However, while the People’s Bank of China is expected to provide only very limited monetary easing with the ECB on hold and the Bank of Japan tightening, the Federal Reserve could still deliver two 25-basis-point rate cuts in 2026, narrowing the gap with other major central banks and pushing the dollar down some more. This would, of course, amplify the USD-denominated return on international equities.
Investment Implications
Getting back to the Christmas cake, a few days after the big day, I normally cut it up into small slices and stick them in the freezer. Over the last eight years, I’ve been privileged to be able to run the Boston Marathon in April on behalf of the Dana-Farber Cancer Institute, and I’ve found Christmas cake to be the perfect running fuel. It is very calorie dense and has a nice blend of sucrose and fructose, to speed me over the fast miles and sustain me over the slow ones.
International stocks should be able to do the same thing for investor portfolios. If 2026 turns out to be as good as perennially-optimistic equity analysts project, international equities should have a year of very strong gains. However, if global economies and markets are upset by any number of possible political, geopolitical or other shocks, international equities are significantly cheaper and higher-yielding than their U.S. counterparts and should help portfolios weather a general downturn in global markets. Either way, if it is not too late for New Year’s resolutions, U.S. investors should resolve to apply international diversification to their very U.S.-centric equity portfolios.