IEFA’s Cyclical Rebound Gains Steam as Dollar Weakness and Global Policy Shifts Create Durable Trade

The recent outperformance of international developed markets is not a permanent structural shift, but a cyclical correction. After a decade of being left behind, the rebound is driven by macro forces that have created a favorable setup for a reversal. The numbers tell the story of a catch-up rally.

Over the trailing 12 months through early March 2026, the iShares Core MSCI EAFE ETF (IEFA) returned +22.88%, decisively outpacing the S&P 500's +17.69%. This momentum-driven gap is the headline event. Yet, viewed through a longer lens, it becomes clear this is a reversal narrative. Over the full five-year period, IEFA's +52.08% return trails the S&P 500's +75.69% by a wide margin. The recent surge closes a significant portion of that gap, but it does not erase the underlying structural underperformance that defined the prior cycle.

This cyclical move is being fueled by several macro factors converging. First, there are valuation gaps. After years of discounting, international developed markets now offer a broader, more diversified portfolio of large-, mid-, and small-cap stocks outside the US. This fund's broad exposure to roughly 3,000 companies across Europe, Japan, and the Pacific provides a potential floor for returns, anchored by steady dividend growth and earnings from sectors like financials and industrials that differ from the tech-heavy US market.

Second, policy divergence is playing a role. As US monetary policy normalizes, the relative appeal of international markets, particularly those with more accommodative central banks, has increased. This shift, combined with a moderating US dollar, has reduced a persistent headwind for international equities. The unhedged currency exposure in funds like IEFA means a weaker dollar directly boosts returns, a dynamic that has supported the rebound.

The bottom line is that this is a cyclical correction, not a new regime. The strong performance is a response to a decade of neglect, driven by valuation, policy shifts, and a changing dollar. It resets the table, but the longer-term structural gap remains. For investors, the setup suggests international markets are no longer dead weight, but the trade-off between diversification benefits and the persistent drag from technology underweighting endures.

The Macro Engine: Growth, Rates, and Currency

The rebound in international stocks is being powered by a confluence of macro forces that are finally shifting in their favor. The key drivers are a change in the global growth trajectory, a moderating US dollar, and a new wave of policy support that is absent in the United States.

The most immediate catalyst has been the decline of the US dollar. For the full year 2025, the dollar fell by almost 9% against a basket of developed-market currencies. This trend, driven by global diversification away from dollar dominance, has removed a persistent headwind for international returns. For US investors, a weaker dollar directly boosts the value of foreign-currency earnings and assets. Analysts note the dollar still appears overvalued relative to peers, suggesting there is room for further moderation, which would continue to support international equities.

More fundamentally, the global growth outlook for 2026 is improving. This acceleration is expected to be driven by the lagged effects of interest rate cuts and increased fiscal support. The JPMorgan Global Manufacturing PMI serves as a key leading indicator, and while it showed near-term weakening in November, the forward-looking components point to resilience. The new-orders component remained above the 50 expansion threshold, and business optimism hit a five-month high. Historically, manufacturing PMIs tend to rise about nine months after central bank easing, and with the European Central Bank having cut rates by 235 basis points from mid-2024 to mid-2025, the transmission to the real economy could begin to materialize in the coming quarters.

This growth catalyst is being supercharged by specific policy moves in Europe and Japan that are absent in the US. Germany is embarking on a massive fiscal stimulus plan, with its 2026 government budget approved and spending set to pick up speed. This is the largest fiscal package since reunification, providing a direct boost to domestic demand. Simultaneously, Japanese companies are enacting shareholder-friendly reforms, aiming to unlock value and improve capital allocation. These are tangible growth catalysts that are not being replicated in the US, where fiscal policy remains more constrained.

The bottom line is that the macro engine for international stocks is now turning over. A weaker dollar provides a tailwind, a more supportive monetary policy environment is beginning to filter through, and targeted fiscal stimulus in key markets is creating a new source of growth. This combination of factors suggests the recent outperformance is not a flash in the pan, but the start of a more durable cycle.

Commodity and Industrial Implications

The macro shift favoring international developed markets has direct implications for commodity markets and global industrial production. The sector and geographic tilt of these markets, dominated by Financials and Industrials, creates a tangible link to the real economy and its cyclical drivers.

This tilt is the core of the diversification story. Funds like the iShares Core MSCI EAFE ETF (IEFA) are weighted heavily toward Financials (23.43%) and Industrials (19.67%), a profile meaningfully different from the US market's tech dominance. This composition directly ties returns to the health of global manufacturing, trade, and capital markets. As the European and Japanese economies benefit from policy support and a weaker dollar, the demand for industrial goods and services from these regions can provide a floor for commodity prices linked to those sectors, such as industrial metals and energy.

The income stream from these markets offers a tangible anchor. The Vanguard FTSE Developed Markets ETF (VEA), for example, currently yields close to 2.9%. This is not speculative income but is supported by a deep bench of mature multinationals in sectors like financials, healthcare, industrials, and consumer staples that generate stable cash flows. In a high-rate environment, this yield provides a tangible return that can be attractive, even as equity prices fluctuate. It reflects the underlying profitability of the industrial and commodity-linked businesses within the portfolio.

Yet, the primary risk to this setup remains currency volatility and geopolitical uncertainty. The recent flows into international equities show a shift from broad exposure to more targeted bets, with early 2026 data indicating strong demand for emerging markets and single-country ETFs. This selectivity highlights a growing wariness. Geopolitical tensions or a sudden reversal in the US dollar's decline could quickly compress returns for US investors, as unhedged currency exposure works against them. For commodity-linked equities, this volatility introduces a layer of risk that can overshadow fundamental growth, making the cyclical rebound more choppier than a pure macro narrative might suggest.

The bottom line is that the international rebound is a real economic story, not just a financial one. It is fueled by a policy-driven acceleration in global industrial activity, supported by a tangible income stream from mature companies. However, the path is not smooth. The very forces that drive the cycle-currency swings and geopolitical friction-can also disrupt it, reminding investors that commodity and industrial exposure is a bet on a stable global order as much as on growth.

Catalysts and Watchpoints for the Thesis

The recent outperformance of international developed markets is a cyclical rebound, but its sustainability hinges on a few forward-looking events and metrics. The thesis depends on the continuation of supportive macro forces, and investors must monitor these catalysts to gauge whether the trend holds or fades.

First, the trajectory of the US dollar and the pace of global interest rate normalization are critical. A weaker dollar has been a key tailwind, and its continued moderation would support international returns. However, the broader cycle is driven by real interest rates and capital flows. If US monetary policy remains more restrictive for longer than expected, it could attract capital away from international markets and reverse the dollar's decline. Conversely, if global central banks, particularly in Europe, can maintain a supportive stance while the US normalizes, the relative advantage for international assets could persist. The key watchpoint is the real rate differential and the direction of the dollar against a basket of developed-market currencies.

Second, the execution and impact of fiscal stimulus plans in Europe and Japan must be tracked. Germany's massive fiscal package is a tangible growth catalyst, but its benefits are lagged. The 2026 budget has been approved, but the actual spending ramp-up and its effect on credit growth and economic activity will be the proof point. Similarly, Japanese corporate reforms aim to unlock value, but their success depends on sustained capital allocation improvements. The risk is that these plans face political or economic headwinds, or that their impact is smaller than hoped, which would dampen the growth engine for international equities.

Finally, investor flows are a leading indicator of sentiment and positioning. Recent data shows a clear rotation within international equities. Demand in early 2026 was exceptionally strong for emerging markets and single-country ETFs, with flows into emerging market equity ETFs exceeding total inflows for all of 2025 in just a few weeks. This selectivity signals a move from broad exposure to targeted bets, which could be a positive sign of conviction. However, it also introduces a risk: if this rotation intensifies, it could signal a rotation away from developed international markets toward more volatile emerging markets, potentially compressing the outperformance of the broader developed-world index. Monitoring the balance between broad international funds and more concentrated bets will be key.

The bottom line is that the cyclical rebound has multiple moving parts. Sustained outperformance will require the dollar to stay in a range-bound or weakening mode, fiscal stimulus to translate into real economic growth, and investor flows to remain supportive of international diversification. Any shift in these catalysts could quickly alter the macro backdrop and the trade's trajectory.