10 reasons to be optimistic about the return potential of non-US equities
A number of favorable trends – from an embrace of shareholder-friendly measures to lower European interest rates – could foster better returns from non-US stocks in the years ahead.
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Tariffs have been dominating the headlines since President Trump announced his plans to raise tariffs on the United States’ trading partners. The reshaped global trade dynamic could provide more justification for investors to diversify their portfolios after a period of extended outperformance from US stocks may have caused them to have lopsided exposure to the US.
Even before the potential impact of tariffs became the central issue on investors’ minds, a number of developments had been underway that suggest international stocks could be poised to deliver stronger performance relative to their US peers. In fact, we see 10 reasons that could justify US investors becoming more optimistic about the benefits of regional diversification and the merits of owning international equities.
- While US stocks experienced exceptional earnings gains over the past decade, international equities had strong earnings gains, too.
US companies’ profits, collectively, soared over the past 10 years. But a look at the factors that drove the returns of stocks around the world, over that time, shows that companies in other countries experienced strong earnings gains, too, even if they were not quite as robust as the earnings growth US companies saw. (See Figure A). Investors didn’t reward non-US companies for those gains anywhere close to the extent they did US stocks, however. While investors’ eagerness to buy US stocks made valuation change a significant contributor to US equities’ performance, negative sentiment about European stocks resulted in valuation change being a detractor from returns (in the UK) or making no contribution at all (for the rest of Western Europe).
Figure A: Non-US markets also had strong earnings gain over the past decade but with limited or negative valuation rerating.
Decomposition of the drivers of each country’s and region’s annualized equity returns over the past 10 years, in US dollar terms
Source: LSEG Datastream, MSCI and Schroders Strategic Research Unit. Data to December 31, 2024, in US dollars. Note: Figures do not sum exactly as the total return is the compound return of the individual components. Analysis is now based on change in 12-month forward earnings and change in the 12-month forward price/earnings multiple. Past performance is not a guide to future performance and may not be repeated.
For US investors, trying to benefit from the earnings gains companies in other regions realized was difficult because the exchange rate between the strong US dollar and other currencies acted as a considerable drag on returns. The tide has already shifted with that dynamic and if higher tariffs and their negative impact on the US economy continue to weaken the dollar, currency exchange could become a significant contributor to returns for US investors who invest in international equities in local currencies. Additionally, with inflation finally returning to Japan, the Bank of Japan (BOJ) is one of the few central banks globally with a bias towards tightening, which should be more supportive of the yen.
2. The earnings gains made by European companies over the past decade have been on par with US stocks beyond the “Magnificent Seven.”
The perceived superiority of US stock performance is based only on the gains that have been made over the past 10 years by the Magnificent Seven (Amazon, Alphabet/Google, Apple, Meta/Facebook, Microsoft, Nvidia and Tesla). While they have seen a nearly five-fold increase in their earnings over that decade, if you remove them from the picture, it becomes clear that the more modest, but still respectable, earnings growth of companies across Western Europe (absent the UK) were on par with the rest of the US equity market over that period. (See Figure B.)
Figure B: Average earnings growth for Western European stocks has been similar to that of US equities, outside of the Magnificent Seven
Next 12-month earnings (US in dollars, Europe ex UK in euros), indexed to 100
Source: LSEG Datastream and Schroders. Data to 12/31/24. Past performance is not a guide to future performance and may not be repeated.
3. A historically significant valuation discount has made the risk/reward profile of international equities more attractive than their pricey US peers.
International equities have been trading at discount to US stocks for 15 years, but, at year-end 2024, that discount reached a level that has not been seen in 50 years. The MSCI World ex US Index was trading at a 44% discount to US stocks, as measured by the MSCI USA Index. That difference is not being driven solely by the high-flying US technology stocks. For almost every industry, international equities trade at a discount to their US counterparts. From that industry-by-industry perspective, the median discount is 27%.
Figure C: The discount on international stocks, relative to US peers, hit a 50-year low at year-end 2024
Value of the MSCI World ex US Index relative to the MSCI USA Index
Source: LSEG Datastream, MSCI, S&P, and Schroders. Data to December 31, 2024. Different indices and time horizons are used for reasons of data availability. Shown for illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country and should not be interpreted as investment guidance. Past performance is not a guide to future performance and may not be repeated.
Expensively priced stocks have much further to fall with the advent of any setback. By contrast, the historically cheap international stocks have much more of a cushion because investors’ expectations for them are already quite muted. Especially, in the light of some of the strong fundamentals that investors have been overlooking – like solid earnings gains – the reward/reward profile of the historically cheap international stocks may look much more appealing than their US counterparts viewed through the same lens.
4. European countries may find a new spirit of cooperation as they look to soften the impact of US tariffs.
Even though the countries of Western Europe came together to form the European Union more than 30 years ago, negotiations between these countries have been notoriously contentious. Still, President Trump’s tariff policy seems to have unleashed a willingness to band together and find ways to help their economies and companies grow amid the prospect of losing US consumers, who may be priced out of buying their products.
Recent elections in a number of countries, including the UK, Spain and Germany, have also fostered political stability and an end to the uncertainty that was prevalent before those election results were known. Also, the rhetoric of the Trump Administration has fueled a shift in priorities within Europe, where many policymakers were already focused on bolstering competitiveness within the region by looking to reduce much of the perceived excessive bureaucracy and regulation that have potentially limited growth.
5. Germany is providing considerable fiscal stimulus to its economy.
This year, the German parliament passed a €500 billion funding package to address the country’s aging infrastructure and also foster the transition to a stable economy. Since 2009, the German federal government has also had to keep a balanced budget, a rule that instituted what is known as a “debt brake.” The Bundestag recently approved a constitutional amendment that will allow defense and certain security-related expenditures that exceed 1% of GDP to no longer be applied to the debt-brake calculations. The increase in defense spending could provide a significant boost for the industrial sector and all the companies that provide the supply chain and support services for the defense sector.
While these measures address important issues like national security and sustainability, they could also provide a considerable boost for the German economy. In our view, the increased infrastructure and defense spending could add 100 basis points or more to the annual growth rate for the German economy
6. Easing monetary conditions across Europe may foster growth.
Since the summer of 2024, both the Bank of England and the European Central Bank have been cutting interest rates. Looser monetary policy supports economic growth. In Europe, falling rates can provide an even bigger boost to economic growth because historically variable-rate loans have been more common there. In the US, only 8% of outstanding mortgages, for example, are adjustable rate.1 This year, 14.4% of the new home loans issued across the euro region have been variable rate.2 As recently as three years ago, that number was 24.6%. In some countries, the percentage is considerably higher. In Spain, for example, 75% of outstanding mortgage debt is in variable-rate products.3 While a drop in policy rates does not always immediately translate into lower mortgage rates, a decline in the benchmark rate usually works its way through loan markets. Reduced borrowing costs frees up cash for consumers to spend in other ways, and companies directly benefit from that increased spending. Lower rates also reduce the cost of borrowing for companies.
Some evidence of the greater potential benefits European companies derive from reductions in rates can be found by looking at how stocks have performed after a rate-cutting cycle began. Over the past 50 years, European stocks saw double the gains after a first cut that their US counterparts did. (See Figure D.)
Figure D: UK and European stocks tend to see better returns after a first interest rate cut
Average market performance after the first interest-rate reduction in rate-cutting cycles over the past 50 years
Source: Berenberg research, Bloomberg, Eikon, as of October 3, 2024. Past performance is not a guide to future results and may not be repeated.
7. Companies around the globe are embracing shareholder-friendly measures like stock buybacks.
Stock buybacks have been a particularly popular measure in the United States, as this return of capital to shareholders can enhance a company’s earnings per share and potentially elevate the stock price. Over the past five years, more companies in a number of other countries, including Japan, France, and Germany, have been applying this strategy. Notably, in 2024, the proportion of companies in the UK executing buybacks exceeding 1% of their outstanding shares surpassed the level seen from US companies. (See Figure E.) This trend underscores a global shift toward leveraging buybacks as a tool to enhance shareholder value.
Figure E: Stock buyback activity has increased outside of the US
Percentage of large companies buying back 1% or more of their outstanding stock shares
Source: LSEG Datastream and Schroders calculations. Data as of 31 January 31, 2025. Change in number of shares estimated based on change in market capitalization/price ratio for each index constituent (based on the full market cap capitalization of each constituent). This avoids any distortions from share splits etc. Using a larger threshold than 1%, e.g. 5%, would not have materially altered the conclusions from this work. Likewise with a smaller 0.5% threshold. There is no guarantee current market trends will continue.
8. Pan-European banks have outperformed the Magnificent Seven for the past three years.
Financial news headlines in the US would suggest the Magnificent Seven have been the only game in town for the past few years. All the attention they have received may have caused US investors to overlook a surprising development: Pan-European banks outperformed the “Mag 7” on a total return basis throughout most of the past three years. (See Figure F.)
Figure F: Pan-European banks have outperformed the Magnificent Seven for much of the past three years, on a total-return basis
Source: LSEG DataStream, as of 3/31/25. The Magnificent Seven are Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia and Tesla. The MSCI Europe Bank Index comprises 32 banks in 15 countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK. Past performance may not be repeated and is no guarantee of future results.
A number of factors have contributed to that performance. In the aftermath of the 2008-2009 Global Financial Crisis, European banks significantly bolstered their capital positions in response to stricter regulatory requirements. Despite a sharp sell-off of these stocks during the Covid-19 pandemic, these banks demonstrated considerable resilience. They strengthened their balance sheets and maintained positive earnings and loan growth, and these measures set the stage for a strong rebound as economies emerged from the pandemic-driven slowdown.
As the Bank of England and European Central Bank have transitioned to rate cutting, the banks have once again been able to take steps to shore up and even grow their earnings. While lower rates could compress their net interest margins, the banks have been adopting multiple strategies -- including diversifying their income streams, focusing more on fee-based services, and exploring mergers and acquisitions -- to enhance their profitability. While loan growth had been slow in 2023 and 2024 because rising interest rates had dampened demand, that trend should reverse now that interest rates are being lowered.
Even with all these positive developments, these banks continue to be cheap relative to their peers around the world. (See Figure G.) Their low relative valuations could present a buying opportunity for investors.
Figure G: Pan-European banks remain a good value relative to their global counterparts
Comparison of pan-European and global banks’ 3-year weighted average price-to-earnings-per-share ratios
Source: LSEG Datastream, as of March 31, 2025. The MSCI Europe Bank Index comprises 32 banks in 15 countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK. Past performance may not be repeated and is no guarantee of future results.
9. More Japanese companies are embracing measures that support profitability.
Several years ago, Japan began exiting an extended period of deflation. It also began to see more positive results from the corporate governance reforms instituted a decade ago, as the government pushed companies to add more independent directors to their boards, increase transparency, and consider returning capital to shareholders through measures such as higher dividend payouts and stock buybacks. Historically, companies have also held a high proportion of other firms’ shares. The practice stemmed from a cultural tradition of supporting peers’ businesses and strengthening relationships. As more companies have increased their efforts to support shareholder value, that tradition is gradually being unwound.
Not owning shares of other firms could enable companies to have much more efficient balance sheets and allocate capital in more ways, including investing more in their own business.
As Japanese companies have become better at capital allocation, their after-tax profitability has increased significantly. That, in turn, has enabled them to return more cash to shareholders through increased dividends and stock buybacks.
10. Japan, like other countries, is doing more to support its currency.
As noted above, over the past 10 years currency exchanges had a considerably negative impact on returns for US investors in foreign stocks, given the strength of the dollar. Japan, in particular, has been actively engaging in measures to shore up the value of its currency. Its government’s efforts have ranged from direct spending in the foreign exchange markets by the Japanese Ministry of Finance to the Bank of Japan ending its negative interest rate policy and Japan’s Finance Minister meeting with the US Treasury Secretary to negotiate ways to foster more stable exchange rates.
Good reasons to see the value of international diversification
For investors who want evidence of catalysts that might set in motion a reversal of the extended period of outperformance of US stocks versus their international peers, there are abundant signs that international stocks could be poised to deliver much stronger relative performance in the years ahead. While US exceptionalism may persist for the time-being, there is no doubt that the longer it persists, the more attractive the risk/return tradeoff gets on the other side of that trade.
Endnotes:
1. “ Federal Reserve Bank of St. Louis, 2/6/24
2. “” Monthly, European Central Bank Data portal, as of 4/2/25 update
3. “” Financial Times, 10/15/23
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