Perhaps one of the biggest challenges for investors is the noise, the constant loud onslaught of information about what is happening in the market and why. The noise is very short-term in nature, dominated by the news of the day or week. Sometimes, underneath all this noise, is a signal that something has changed of a more meaningful or long-term nature. It’s this signal that can make us more money or help sidestep danger. The rise of AI or digital assets are signals, with no shortage of noise around them along the way, as is the return of inflation. These are not new signals; they’re already many years old.
One newer signal is potentially a shift to rebalance portfolios towards more international and emerging market equities, and consequently, less U.S. equities. This has the potential to be a very long signal. Of course, the cautionary narrative is the many times over the past decade that investors got excited about international equity outperformance only to suffer as these supposed signals turned out to be more noise and the U.S. resumed its performance dominance.
So what are the pros and cons of investors leaning more into international at the expense of their beloved U.S. equity allocations? We’ll share our thoughts, breaking them down into the near-term and longer-term secular considerations. Signal or noise: you be the judge.
Investors in 2025 have certainly taken note of the relative performance among different equity markets. Not that anyone should be complaining; they’re all in the green, but the disparity is rather wide. The vast majority of this divergence occurred before the Liberation Day tariff sell-off; since then, markets have largely moved higher together. Is this noise or a signal?
Longer-Term Considerations:
Long cycles – The history of markets and relative performance certainly points to very long-term cycles of relative outperformance (chart 1). The duration of these cycles often surpasses even decades. And given that the most recent long cycle strongly favoured U.S. equities, the stage does seem set for a reversal in favour of international equities. We’re not saying it’s as easy as saying that in the 80s international won, the 90s U.S. won, the 00s international won, the 10s to mid-20s U.S. won, so naturally it’s international’s turn. Or maybe it is that simple. Whether it has truly started or not, the long-term relative performance setup for international is certainly in place.
USD declining – You can’t talk international investing without having a view on currency. Forecasting where a currency is going to go over the next few quarters is very challenging. But, among developed nations, there is a strong long-term reversion to the mean. And while not crazy extreme, the USD is on the expensive side of the mean. It’s also worth noting that the relative equity market outperformance of the U.S. or international often kicks off from low relative value on the currency side. From these current levels, it favours international over U.S.
The U.S. dollar does enjoy the status of global reserve currency, and this comes with a bit of a premium valuation. While we do not think the U.S. dollar will lose its reserve currency status anytime soon, it is certainly losing some of that status. Confiscating other central banks’ reserves for political reasons, whether you agree with the move or not, doesn’t help your status as global reserve currency. Nor does the policy uncertainty of the current administration from chipping away at central bank independence to tariffs. Tariffs will slow global trade, and that means less buying of USD.
We’re not U.S. dollar bears, as potential slowing of global economic growth may bid up the dollar, but the longer-term trend in coming years is likely on the downside. And that means other currencies likely appreciate, again favouring international (unhedged obviously).
Everyone is overweight U.S. – Being a contrarian investor is often the better approach to simply chasing a trend, especially if that trend appears to be in its late innings or perhaps already over. Even if you have some hesitancy towards the view that international is poised to outperform U.S. equity markets, there’s no denying that after so many years of outperformance, most portfolios have a healthy U.S. overweight. Chalk it up to recency bias or performance chasing; it would seem most portfolios are heavy on America and light everywhere else. When most investors are on one side of the boat, it is usually best to move to the other side, or at least back to a more neutral position.
Given the setup and current exposures, a more international mix may be prudent. And if you think you missed the boat, we’d remind readers that if this signal is true, it may have years to run.
Near-Term Considerations:
U.S. equities technically stretched - As we enter the back half of the summer, U.S equity markets find themselves in a precarious position. Technically, U.S. equities, specifically the S&P 500 and Nasdaq, are two of the most overbought indices globally. The relative strength index (RSI) is flashing warning signs and well into overbought territory.
While this doesn’t mean an imminent correction, it does suggest a high level of short-term froth in the market. Prices are rising, the trend strength remains strong, and the bulls remain in control for now. While the bullish momentum continues, the mathematical reality of mean reversion suggests current levels may prove unsustainable without extraordinary fundamental support.
Conversely, European, Asian, and emerging markets present a very different technical picture. These international markets remain largely range-bound and sit comfortably below overbought levels, suggesting there is room to run should sentiment shift once again from the dominant AI trade. This divergence creates an opportunity where international diversification may offer both defensive characteristics and upside potential.
Volatility lull - One of the more interesting patterns in market seasonality is the well-known summer lull. As the chart below depicts, over the past twenty years, the last three weeks of July have had the lowest average VIX readings. This year proves no exception. Over the past two months, there have been precisely three days when the S&P 500 has moved more than one percent in either direction. It’s been an unusually calm market backdrop despite the seemingly high level of geopolitical uncertainty.
This calm in the summer doldrums presents an ideal time to reconfigure portfolios. There is less noise to obscure the decision-making process, and emotions are calmer. This all makes it easier to focus on the long-term and make shifts to strategic portfolio asset allocations.
AI is the difference maker - This year’s international outperformance predominantly took place in the first few months. Over that time, there were two significant catalysts. The first was the fiscal policy pivot from Germany. They announced big spending plans on defence and other infrastructure projects. This shift away from a more austere fiscal policy stance excited markets about future European growth prospects.
The second, and more substantial reason, was the DeepSeek moment that temporarily disrupted the AI investment narrative. The mini panic across AI stocks impacted companies both directly and indirectly related. It also showed how broad the narrative is across U.S. markets. This mini correction wasn’t driven by fundamentals or earnings misses, but by cracks in the sentiment. For a few days, it felt like the scaffolding holding up the AI trade might falter.
The moment passed, and the rally resumed. As of writing, we briefly had two $4-trillion companies in NVIDIA and Microsoft. Valuations based on the price-to-sales ratios are now at all-time highs, matching levels last seen in 2021, as seen in the chart below. The core reason for the high price-to-sales ratio is that investors are willing to now pay massive premiums for companies that they believe will have explosive revenue growth in the future.
The AI party continues, though we might now be in the late evening, but it really doesn’t matter because nobody knows how long it will go on. It could be lights out at 11 pm, or it could continue to sunrise. What we do know is that enthusiasm is rampant, and there are legitimate reasons to be excited.
But no matter how good the party is, it can always be spoiled. There’s no guarantee that those who spend the most and throw hundreds of millions of dollars to recruit AI all-stars will win this race. For all we know, there isn’t just one winner. China could very well end up as an AI winner. In investing, you want to cover your bets, so having some exposure to China could make sense to ensure a more balanced approach that includes emerging market positions that benefit from parallel AI developments.
The current valuations and technical divergence suggest now is a good time to rebalance and tilt towards a healthy overweight international exposure. Not only does this shift diversify away from U.S.-centric risks, but it also offers a broader range of potential winners in evolving global themes. Rebalancing doesn’t require a bearish outlook; it simply reflects the discipline of managing risk and recognizing that no rally lasts forever. With volatility low and U.S. sentiment increasingly euphoric, it’s worth pausing to ask: is your portfolio as diversified and future-proof as it could be?
International is a fixer-upper – There’s no denying that America has a lot going for it. Strong entrepreneurial populace, amazing access to capital, and generally corporate-friendly regulations. Meanwhile, many international markets suffer from a more challenging regulatory environment, challenging demographics, or slower economic growth. This is plain to see if you compare the earnings growth for the S&P vs EAFE over the past 10 years. $1 of earnings for the S&P grew to $2.65 over the past ten years. For international developed markets, that same $1 only grew to $1.66, clearly explaining the relative outperformance over the past decade for the U.S. equity market.
But just like in real estate, sometimes the biggest gains come from the fixer-upper opportunities compared to the new modern home. Replacing the windows and adding a new coat of paint can go a long way in creating value. This may be the case for international in different ways in different regions.
Fiscal spending to spur economic growth appears to be accelerating. Keep in mind that, coming out of Covid, the U.S. continued to run large spending deficits (a.k.a. fiscal spending) while other regions from Europe to Japan brought their deficits down much more. This does partially explain the economic growth gap over the past few years, with the U.S. leading. But now Germany has increased fiscal spending plans, and the DAX is one of the best markets so far this year. Others appear to be following the lead.
Japan has continued its long journey of improving corporate governance and making companies more shareholder-friendly. Meanwhile, thanks in part to retirement saving structures, individual investors are increasingly becoming equity holders within retirement plans as compared to simply parking cash at the post office. Equity ownership in Japan is still low at 10-15% compared to 40-50% in the U.S. But they’re catching up.
Add the policy uncertainty coming out of the U.S. from tariffs to defence, and this has become a bit of a kick in the butt of other nations to start pulling levers to increase their own growth prospects or attract capital. Cutting red tape, fiscal spending on economic growth, and redistributing trade are all positive moves in the right direction.
Rate of change matters in markets, and it would appear that international markets, generally speaking, are becoming a bit more investor-friendly. America is still the gold standard, but if the gap narrows, so could the valuation gap.
Valuations – No need to beat this repetitive drum on valuations; the world knows the valuation spread is historically wide between the U.S. and international markets, which has been the case for many years. The S&P 500, at 22.5x forward earnings estimates, which has proven peak valuations over the past decade, is still expensive compared to Asia at 16.5x and Europe at 14.5x. International valuations are actually a bit higher now than a year ago, mostly due to some price appreciation.
Headline valuations are often skewed by a few names for market-cap-weighted indices. Another lens is simply looking for the number of index members trading above or below a certain threshold, in this case, 15x price-to-earnings. The S&P only has 23% of its index constituents trading below 15x, Canada is not far behind at 33%, while Europe and Japan have almost half index members below 15x.
Valuations are how much you’re paying for earnings, but they don’t capture earnings growth. The U.S. is still enjoying stronger earnings growth than international developed markets in 2025, albeit the spread is lower than in previous years. But 2025 is now half over, and expectations for international trade have been brought down a large amount due to tariff fears and uncertainty. Again, this lowers the bar for future growth. Estimates for 2026 are roughly equal across developed markets, and given valuations spread certainly favours international.
Touching on emerging markets (EM), we are rather optimistic. EM has performed well this year, even given certain well-known headwinds. In past years, one would have thought rising tariffs and higher global interest rates would really hurt EM, but the markets and economies have proven rather resilient. In aggregate, they have been cutting interest rates ahead of developed markets, which has helped their economies. And in contrast to the U.S. dollar’s general weakness, many EM nations are commodity-heavy, providing a potentially valuable diversifier for portfolios.
Market Cycle & Portfolio Positioning
Our market cycle indicators have improved over the past month, with a notable uptick in global economic signals. In fact all eight are bullish, providing additional support for a reasonably stable global economy. The U.S. economy improved a little bit, but it remains rather mixed.
All five U.S. housing signals are bearish; those higher mortgage rates continue to weigh on this cyclical and remain an important part of the U.S. economy. Employment and consumer sentiment remain supportive as leading indicators and recession probabilities are bearish.
Final Note
Is the relative outperformance of international equity markets compared to the U.S. a signal of a changing long-term trend or just noise? Nothing is ever certain, but the supporting evidence certainly has us believing the signal has a higher probability. Couple this with the pre-existing prevalence of overweight U.S. and limited international equity exposure, and circumstances may encourage a more balanced allocation. There’s no denying the AI theme could continue to drive U.S. equity outperformance, but themes rarely play out as market participants expect. And with the S&P in overbought territory, it could prove a good time for some rebalancing.
— Craig Basinger, Derek Benedet, and Brett Gustafson
Sources: Charts are sourced to Bloomberg L. P.
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