US and International Equities: A Narrowing Gap?

Over the last year, we have seen a significant divergence in performance between two key global equity markets, as international equities outperformed US equities. This marked a notable shift from the prior decade, during which US stock market indices consistently outperformed most global markets, particularly developed international equities represented by EAFE (Europe, Australasia, and the Far East).

From the early 2000s through the recovery following the Global Financial Crisis, EAFE stocks, measured by the EFA ETF, generated returns broadly comparable to those of US equities. However, beginning around 2013, US equities began to show persistent outperformance. On both a year-by-year and cumulative total return basis, US equities, as measured by the S&P 500, have decisively outpaced EAFE stocks compounding at 15.2% versus 7.1% since 2013 respectively. That dynamic shifted in 2025, when EFA posted nearly double the return of SPY (+31.6% vs. +17.7%), and through the first two months of this year that outperformance continued.

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Much of the literature on diversified portfolio construction has long encouraged investors to maintain international equity exposure alongside US holdings. Yet for more than a decade, that allocation has generally caused such portfolios to lag a US-only approach.

This raises an important question: was the recent international outperformance cyclical or structural? It is unlikely that this can be answered definitively, but decomposing the sources of return across these markets can help determine whether the trend is likely to persist.

It is also worth noting that in the past week, following the escalation of the Iran conflict, EFA was far more sensitive to the rise in volatility. Whether this marks the beginning of a reversal in the recent international outperformance remains an open question.

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EFA Breakdown and Return Attribution

EFA tracks large- and mid-cap stocks across 21 developed markets outside the US and Canada, including Europe, Japan, and Australia. Japan is the largest country weight at roughly 22%, followed by the UK, France, Germany, and Switzerland. Sector-wise, Financials and Industrials dominate at 25% and 19% respectively, with Tech a distant fifth at just 8%. Top holdings include ASML, HSBC, AstraZeneca, Novartis, and SAP.

EFA's +31.6% in 2025 had four primary drivers — a weakening dollar (contributed ~8%), a Financials-led sector rally, a surging Industrials sector fueled in part by Europe's historic rearmament boom and broad geographic strength that carried across the continent. The deeply discounted valuations, both historically and relative to the US, also played a key role in the outperformance.

Below, the return gap between EFA and its currency-hedged counterpart HEFA illustrates just how much work the dollar did in 2025. The spread represents the direct contribution of dollar weakness to EFA's outperformance. For US equity investors, that same dynamic worked in reverse, as a weakening dollar was a quiet but meaningful headwind on relative returns.

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Cyclical or Structural?

The case for US equity outperformance over the past decade was very much grounded in fundamentals. S&P 500 earnings compounded at roughly 8% annually over the last ten years, while EAFE earnings grew at just ~3%. That gap, sustained over time, justified both the valuation premium the US commanded and the persistent underperformance of international allocations in diversified portfolios. The Magnificent Seven deepened the divergence further, earning additional multiple expansion through their entrenchment in the secular growth themes that defined the decade, such as cloud infrastructure, digital advertising, consumer technology and more recently AI.

By contrast, EAFE entered 2025 deeply discounted, with its forward P/E well below its long-term median of roughly 15x. The 2025 rally changed that, as a combination of accelerating earnings growth and valuation re-rating pushed EAFE's multiple back in line with its historical median. The S&P 500, meanwhile, remains elevated at approximately 22x forward earnings against a historical median closer to 19x.

Looking ahead, the earnings story becomes the central question. Consensus forecasts call for S&P 500 earnings growth of approximately 13–14% in 2026, while EAFE is expected to deliver 10–11%, its strongest showing in years. If those estimates prove accurate, it would mark a genuine narrowing of the earnings growth gap that has defined the divergence since 2012. Whether that convergence is durable, driven by structural tailwinds or simply a cyclical acceleration that fades as currency tailwinds reverse, remains an open question. EAFE has a long history of entering years with optimistic earnings forecasts and falling short. The 2026 vintage will be worth watching closely.

Image Source: MSCI, S&P Global

Not a Zero-Sum Trade

The instinct to frame global equity allocation as a choice may be the wrong lens. The more interesting observation heading into 2026 is that both markets appear to have legitimate tailwinds, and the conditions that drove their divergence over the past decade are gradually normalizing rather than reversing.

The S&P 500, despite being outpaced in 2025, still delivered a strong year in absolute terms. Earnings growth remains robust, the domestic economy has proven resilient and the secular themes anchoring the index's largest weights (AI infrastructure, cloud computing, and digital platforms) show no signs of exhausting themselves. A slower year of relative performance is not the same as deterioration.

For EAFE, 2025 was a year of recalibration. Earnings growth re-accelerated, valuations mean-reverted toward historical norms and structural catalysts, Europe's defense spending commitment, Japan's corporate governance reforms, and a weaker dollar provided a durable foundation. The index enters 2026 on firmer footing than it has in years.

It is also worth noting that the distinction between domestic and international exposure is less precise than index labels suggest. S&P 500 companies derive a substantial share of revenues from outside the United States, while EAFE constituents tend to be more dependent on their home markets.

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