For more than a decade, betting against American exceptionalism in equities was a losing proposition. From 2010 through 2024, U.S. stocks outperformed international markets by a cumulative 503 percentage points, with international equities winning in only three of those fifteen years. Then came 2025—and everything changed.
The Numbers Don't Lie
The MSCI All Country World ex-USA index gained 29.2% in 2025, handily outpacing the S&P 500's gain of 16.4%. That 13-percentage-point margin represents the widest international outperformance since 2017 and one of the largest reversals in modern market history.
Both the Morningstar Developed Markets ex-US Index and the Morningstar Emerging Markets Index beat their American counterpart by more than 10 percentage points. For investors who had long abandoned international allocations as dead weight, the reversal was a costly reminder that cycles eventually turn.
"One of the biggest and most underappreciated surprises of 2025 has been the extraordinary outperformance of emerging market equities," noted Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management. The surprise wasn't just the outperformance—it was the magnitude.
Regional Standouts
South Korea's Kospi index emerged as the global star, soaring nearly 76% in 2025 and posting its best year since 1999. The rally was driven primarily by semiconductor stocks benefiting from AI-related demand, with Samsung Electronics and SK Hynix leading the charge.
Japan's Nikkei 225 rose 26%, extending gains into a third consecutive positive year. Japanese stocks benefited from corporate governance reforms, a weak yen that boosted exporters, and increased foreign investor interest following decades of neglect.
European markets also participated in the rally, with the Stoxx Europe 600 gaining approximately 18%. Defense stocks were particular standouts—German manufacturer Rheinmetall surged 154% as European nations rushed to bolster military spending amid ongoing geopolitical tensions.
The Dollar Tailwind
A weakening U.S. dollar provided substantial support for international returns. The dollar index fell approximately 9.4% in 2025—its worst year since 2017—as the Federal Reserve cut interest rates and concerns mounted over fiscal deficits and trade policy.
When the dollar weakens, investments denominated in other currencies become more valuable when converted back to dollars. For U.S. investors holding international stocks, currency movements added several percentage points to returns beyond local market performance.
The dollar's decline reflected narrowing interest rate differentials as other central banks held rates steady while the Fed cut, as well as growing concerns about U.S. fiscal sustainability and the potential impact of aggressive trade policies on American competitiveness.
Valuation Mattered—Finally
Heading into 2025, the valuation gap between U.S. and international stocks had stretched to historic extremes. The S&P 500 traded at roughly 22 times forward earnings, while international developed markets traded at approximately 14 times—a 57% premium for U.S. exposure.
Valuation rarely matters in the short term, but over longer periods it tends to be the dominant driver of returns. The extreme gap created an incentive for global investors to look beyond U.S. borders, and 2025 saw that rotation finally materialize.
Fidelity's international stock outlook noted that "several key factors have contributed to the 2025 success of international equities, including improved valuations, post-pandemic economic normalization, and currency tailwinds."
Structural Changes in Emerging Markets
Beyond cyclical factors, structural improvements in emerging markets contributed to their outperformance. Many developing economies strengthened fiscal positions, built foreign exchange reserves, and implemented reforms that improved corporate governance and investor protections.
The AI boom also reached emerging markets in unexpected ways. Taiwan and South Korea—home to the world's most advanced semiconductor manufacturers—captured significant share of the global AI infrastructure buildout. Indonesia and India attracted manufacturing investment as companies diversified supply chains away from China.
What It Means for 2026
The critical question for investors: Is 2025 the beginning of a sustained international cycle, or a one-year anomaly before U.S. dominance resumes?
Charles Schwab's 2026 outlook argues that "international stocks seem set to shine" based on continued valuation advantages, improving economic fundamentals in Europe and Asia, and potential dollar weakness as U.S. fiscal concerns mount. The firm recommends investors maintain meaningful international allocations rather than treating them as optional.
However, U.S. bulls point to America's continued leadership in artificial intelligence, superior corporate earnings growth, and more flexible labor markets as reasons to expect the U.S. premium to persist. The incoming Trump administration's pro-business policies could also favor domestic equities.
Portfolio Implications
For individual investors, the message is clear: diversification still matters. The years of U.S. outperformance convinced many to abandon or minimize international holdings—a decision that cost dearly in 2025.
A standard diversified portfolio typically allocates 30-40% to international equities, roughly proportional to non-U.S. share of global market capitalization. Investors who drifted from those allocations during the U.S. bull run may want to rebalance.
The 2025 reversal serves as a reminder that market leadership rotates, often suddenly and with little warning. Predicting which region will outperform in any given year is notoriously difficult—which is precisely why diversification remains the only free lunch in investing.
After 15 years of U.S. dominance, international markets reminded investors that the world is bigger than the S&P 500. Whether 2026 extends the trend or reverts to American leadership, the lesson of 2025 is worth remembering: never assume today's winners will be tomorrow's.
