International Stocks Outperformed U.S. in 2025: The Case for Global Diversification Grows Stronger

American investors' devotion to home-country stocks may have finally cost them. In 2025, international equities delivered their best relative performance in years, with the MSCI All Country World ex-USA index gaining 29.2%—nearly doubling the S&P 500's respectable 16.4% return.

The outperformance extended across regions and market types. Emerging markets gained 30% through November, while European stocks rallied on expectations of fiscal stimulus. Even Japan, after years of relative stagnation, participated in the global advance. For investors who heeded years of advice to diversify internationally, 2025 provided welcome vindication.

The Tide May Be Turning

U.S. stock market dominance has been so persistent over the past 15 years that many investors stopped questioning it. The S&P 500 outperformed international developed markets in 11 of the 15 years through 2024, leading many to conclude that American exceptionalism extended to equity returns.

But 2025 marked a potential turning point. Several factors converged to favor international markets:

• Valuation gap: U.S. stocks entered 2025 trading at historically elevated multiples, while international markets remained attractively priced
• Dollar weakness: The U.S. dollar's decline boosted returns for U.S. investors holding foreign assets
• Policy shifts: European fiscal stimulus and Japanese monetary normalization supported local markets
• Sector composition: International indices benefited from exposure to cyclical sectors that outperformed

"The era of U.S. market dominance may not be over, but investors who assume it will continue indefinitely are taking a significant bet. Diversification remains the only free lunch in investing."

— Global equity strategist at a major asset manager

Europe's Fiscal Awakening

One of the most significant developments supporting international equities was Europe's pivot from austerity to growth-oriented fiscal policy. Germany, long the continent's fiscal hawk, announced plans to spend half a trillion euros on defense and infrastructure—a dramatic shift that signals a new era for European investment.

The multiplier effects of this spending extend far beyond government contracts. Banks stand to benefit from increased lending activity, construction companies from infrastructure projects, and defense contractors from rearmament programs. The ripple effects could support European economic growth for years.

Moreover, the European Central Bank has maintained an accommodative monetary stance even as the Fed has turned cautious. Lower European interest rates support equity valuations and encourage risk-taking, creating a favorable environment for corporate earnings growth.

Emerging Markets: The Forgotten Opportunity

Perhaps no segment of the global equity universe offers more compelling valuations than emerging markets. With a price-to-earnings growth (PEG) ratio of just 0.9x—compared to 1.5x for the U.S. and 1.3x for Europe—EM stocks appear to offer better growth at lower prices.

The case for emerging markets in 2026 rests on several pillars:

• Lower interest rates: Many EM central banks have already cut rates, providing monetary support
• Attractive valuations: EM indices trade at significant discounts to developed markets
• Governance improvements: Corporate governance reforms in key markets like Korea and Japan
• China stabilization: Signs of bottoming in the Chinese private sector after years of weakness

Over the next two years, emerging markets offer slightly better earnings growth projections (14.9% CAGR) than the S&P 500 (14.5%) at considerably lower valuations. For long-term investors, the risk-reward appears favorable.

The Dollar Wild Card

Currency movements can significantly amplify or diminish returns for U.S. investors holding international assets. When the dollar weakens, foreign currency gains add to local market returns; when it strengthens, they subtract.

The dollar's trajectory in 2026 will depend on several factors:

• Interest rate differentials: Fed cuts would narrow the rate advantage that has supported the dollar
• Fiscal concerns: Growing deficits may weigh on dollar sentiment
• Global growth dynamics: Stronger international growth attracts capital away from the U.S.
• Trade policy: Tariffs can strengthen the dollar in the short term while creating long-term headwinds

Many strategists expect the dollar to weaken modestly in 2026, which would provide an additional tailwind for international equity returns. However, currency forecasting is notoriously difficult, and investors should focus on long-term fundamentals rather than short-term currency bets.

How to Think About Global Allocation

For American investors considering increased international exposure, several approaches merit consideration:

Market-cap weighted global: A total world index allocates roughly 60% to the U.S. and 40% to international markets based on market capitalization. This approach provides broad exposure while still maintaining significant U.S. allocation.

GDP-weighted: Allocating based on economic output would result in lower U.S. exposure (roughly 25%) and higher international allocation. This approach appeals to those who believe valuations will eventually converge with economic fundamentals.

Equal regional weights: Splitting exposure equally between U.S., developed international, and emerging markets provides maximum diversification but requires conviction that the U.S. premium will narrow.

Tactical tilts: Some investors prefer to adjust allocations based on relative valuations and momentum, overweighting regions that appear cheap and underweighting those that seem expensive.

The Risks of Going Global

International investing isn't without challenges. Currency volatility can amplify losses as well as gains. Political risks in emerging markets can emerge suddenly. Corporate governance standards vary across countries, and accounting practices may be less transparent than in the U.S.

Additionally, the factors that have supported U.S. outperformance—technological leadership, flexible labor markets, deep capital markets—haven't disappeared. The case for international diversification rests on valuations and reversion to mean, not on U.S. decline.

The Bottom Line

After years of disappointing relative performance, international stocks demonstrated in 2025 that they remain an essential component of diversified portfolios. The case for global exposure—attractive valuations, improving fundamentals, and potential dollar weakness—appears as strong as it has been in years.

This doesn't mean investors should abandon U.S. stocks. But it does suggest that the extreme home bias common among American investors may be exacting a cost in terms of both risk and return. In a world where the U.S. represents only about 25% of global GDP but 60% of world market capitalization, some rebalancing toward international markets may be prudent.

For most investors, the question isn't whether to own international stocks, but how much. The answer depends on individual circumstances, time horizons, and risk tolerance. But the lesson of 2025 is clear: diversification works, and assuming U.S. dominance will continue forever is a bet, not a certainty.