Reevaluating Regional Diversification: The Case for Non-US Stocks

Equity markets outside the US have underperformed for years. Is that about to change?

For more than a decade, equity investors with allocations outside the US have faced ongoing frustration. The seemingly unstoppable US stock market opened a yawning performance and valuation gap with the rest of the world, rendering regional diversification ineffective.

Stocks in Europe, Asia and emerging markets lagged those of American technology titans and US peers. So investors around the world put their faith and fortunes in US stocks, which delivered handsome rewards.

The era of US exceptionalism now faces a reckoning. President Trump’s trade war has been the initial catalyst by potentially raising hurdles for US earnings, yet the story runs deeper than tariffs. In our view, the fundamentals that drive regional markets and individual stocks became imbalanced over years, and as a result, equities outside the US are ripe for recovery. Of course, plenty of US stocks will still offer superior long-term return potential. However, we think the stage is set for a shift in market dynamics that should prompt investors to revisit regional allocations and consider adding exposure beyond the US.

Gauging the Valuation Gap

Every equity investor is familiar with the extraordinary trajectory of US stocks over the last decade. US gains have been led by the mega-cap stocks, now known as the Magnificent Seven. But the US stock surge wasn’t only about the giants. In fact, even if you strip out the Magnificent Seven, the S&P 500 returned 1.8 times more than the MSCI EAFE Index of non-US stocks since 2000 (Display). Most of that gap developed since 2015.

Relative valuations reversed. In March 2000, the MSCI EAFE traded at a price/forward earnings (P/FE) premium of 17.5% to the S&P 500, just as the dot-com bubble began to burst. By May 2025, the valuation of non-US stocks was 24% lower than US stocks—a near-record discount for the 21st century.

This trend wasn’t driven by a single country or region. Europe, Japan and emerging markets all traded near their deepest discounts to US and global developed-market stocks since 2010 by the end of May. For example, the P/FE of the MSCI Europe Index was 25% lower than that of the MSCI World Index, versus a 12% average discount since 2000; the MSCI Emerging Markets Index traded at a 36% discount to global developed-market stocks.

A Big Discount Isn’t Enough

But a big discount alone doesn’t make a persuasive case for non-US stocks. After all, valuations outside the US have been so low for so long that investors are understandably skeptical of an inexpensive price tag. Perhaps US stocks really do enjoy a fundamental advantage that deserves a persistent premium.

Historically, however, that wasn’t the case. Non-US stocks weren’t always the underdog. Our research shows that MSCI EAFE earnings growth outperformed that of the S&P 500 during the 1970s, 1980s and the 2000s on an average annual basis. So it doesn’t take a stretch of the imagination to envision a reversal if new catalysts for change materialize.

Why Did the US Outperform?

To evaluate the possibility of a shift, we first must understand what fueled US valuations in the first place. Earnings, cash flows and macroeconomic growth all deserve scrutiny.

Earnings Growth: Distorted by the Mega-Caps

In equity markets, long-term returns are usually driven by earnings growth. Investors might naturally think that US earnings growth has been much stronger than non-US earnings growth in recent years.

True, but a deeper look is warranted. While earnings growth for the S&P 500 outpaced the MSCI EAFE’s over the last decade, the gap was mostly driven by the mega-caps. Without the Magnificent Seven, S&P 500 earnings growth was surprisingly similar to the MSCI EAFE’s over the last decade (Display).

In other words, the price/earnings (P/E) divergence between US and non-US stocks hasn’t been caused by a dramatic discrepancy in the “E” of the P/E equation. This also means that US corporate earnings aren’t sprinkled with fairy dust; conversely, the earnings growth potential of non-US companies isn’t inherently inferior.

New evidence is coming to light as the trade war upends businesses. Consensus earnings growth estimates for US companies in 2025 fell from 12.9% at the end of last year to 8.1% in late April. In a mirror image, MSCI EAFE earnings estimates jumped from 4.6% to 8.1% over the same period. These swings remind us that a regional earnings advantage isn’t written in stone.

Profitability: Decomposing US Dominance

If it wasn’t earnings, perhaps profitability explains the US preeminence? Here, too, technology and mega-cap stocks have shaped the story.

In the S&P 500, the weight of technology stocks plus the Magnificent Seven (which includes three non-technology names) more than quadrupled over the last 30 years to 44.6% in early 2025 (Display). Those “tech+” companies more than doubled their free-cash-flow (FCF) margins, a metric that we believe is an important profitability metric. The combined effect of a heavy index weight and outsized profit margins propelled S&P 500 margins to nearly 10% in 2025.

What happened outside the US? There, the weight of technology stocks hasn’t changed much over the last 30 years. Yet, the MSCI EAFE’s profitability climbed to 7.4%—the same as that of non-technology S&P 500 firms. The bottom line: non-US companies have almost the same FCF margin as US companies, excluding the tech+ cohort, so profitability doesn’t explain the persistent valuation gap.

GDP Growth: Misalignment in Global Equity Markets 

Beyond earnings and profitability dynamics, the relationship between macroeconomic growth and markets has also become misaligned over the last decade. Since 2015, US equities contributed 74% to the return of the MSCI World, an increase of 26 percentage points (Display). But the US share of global GDP only rose by 9 percentage points over the same period. Given the global nature of the US heavyweight stocks, we would expect some difference between US GDP and its share of global markets—but not quite so wide.

While equity markets aren’t the economy, they should reflect the economy. When the broad collection of publicly traded companies in a market grows so much faster than GDP, we think it indicates an imbalance in capital allocation trends that may not be rooted in reality. Just as a company’s share price may become detached from its fundamentals, an equity market that’s out of sync with the real economy points to a distortion that could unwind.

Signs of Change in Early 2025

Market trends in early 2025 could herald a rebalancing of global equity-market returns, in our view. The starting point is the heavy concentration of US equities in a small group of mega-cap stocks.

By the end of the first quarter, the Magnificent Seven accounted for almost a third of the S&P 500’s $51.8 trillion market capitalization. During the first quarter, returns among the mega-caps diverged amid growing scrutiny of their earnings power. To be sure, the Magnificent Seven as a group did better in the second quarter, suggesting that a potential reduction of market concentration won’t unfold in a straight line. If technology disruptors are disrupted over time and US market concentration unwinds further, we expect to see more rebalancing toward non-US stocks.

During the first half of 2025, US stocks underperformed global markets amid growing concern that Trump’s tariff policies could trigger an economic slowdown that might curb US consumer spending. Increased defense spending in Europe and Japan also helped boost non-US markets. European and emerging-market stocks have done particularly well, outpacing the S&P 500 through early June.

The underperformance hasn’t gone unnoticed by those closest to the companies. During the first quarter, US corporate insiders sold shares of their own companies at a faster pace than we’ve seen in two decades, according to a recent Financial Times analysis. This implies that insiders themselves may be questioning whether the days of unbridled US outperformance may be nearing an end.

Catalysts for Change

What needs to happen for non-US stocks to post a sustained recovery? As mentioned earlier, low valuations aren’t enough. To some extent, US policies could continue to help spur fund flows away from the US if tariffs inflict significant damage on American companies and the economy. Increased fiscal spending in Europe and Japan and Japan’s long-awaited exit from persistent deflation could also be catalysts for non-US equity returns and fund flows. A shift in flows could become a virtuous circle, boosting returns in Europe, Asia and emerging markets, which would draw more capital and investors away from the US over time.

Cracks are already appearing in the market. US stocks underperformed non-US stocks this year through mid-June. The cost of credit default swaps on US sovereign debt has risen recently to a relatively high level, which suggests eroding confidence in the US as a safe-haven investment destination. Meanwhile, the 30-year US Treasury yield has risen sharply while the weakening US dollar is widely expected to continue its decline. Taken together, these developments imply that the risk level of US equities has risen.

Nobody can predict how a potential revival of non-US stocks might play out. As we see it, the key to capitalizing on a change in sentiment is to be selective by identifying companies with quality businesses and overlooked earnings growth potential, which will likely lead a long-term recovery. Since non-US stocks have been unloved for so long, companies with strong fundamentals can be found across the market—from value and growth equities to defensive stocks. Investors with different risk appetites can discover multiple paths to capture a potential broadening of regional return patterns in equity portfolios.