International Equity Index Funds: A Strategic Counterbalance to Overvalued U.S. Markets

The U.S. equity market, long a cornerstone of global investing, has reached valuation levels that raise questions about its long-term sustainability. As of Q4 2025, the S&P 500 trades at a forward P/E of 20.9x, a level not seen since the pre-2000 tech bubble era. In contrast, international equities-represented by the MSCI ACWI ex USA Index-trade at a forward P/E of 13.4x, a 35% discount to their U.S. counterparts. This valuation gap, while narrowing slightly from historical lows, suggests a compelling case for investors to reconsider the role of international equity index funds in their portfolios.

Historical Precedents: When International Markets Outperformed

History offers instructive parallels. During the 1980s, as U.S. markets grappled with inflation and regulatory shifts, international equities surged. The MSCI ACWI ex USA Index delivered a 299% return over 5.6 years, outpacing the S&P 500 by a margin that remains unmatched in modern investing. Similarly, in the aftermath of the 2000 dot-com crash, global markets rebounded while U.S. tech stocks languished. From 2000 to 2009, the MSCI Emerging Markets Index grew 98.2% from a $1,000 investment, while the S&P 500 declined to $764. These periods underscore a recurring theme: when U.S. markets become overvalued, international equities often re-rate to reflect their intrinsic value.

The 2025 landscape mirrors these historical patterns. The S&P 500's elevated P/E ratio of 24.16 at the start of 2025 exceeds its 20-year average, while international indices like the FTSE Global All Share ex USA trade at 16.8x. This disparity is not merely a short-term anomaly but a structural shift. As Morgan Stanley notes, international stocks now offer a 30% valuation differential compared to U.S. equities-a gap that historically has closed with significant returns.

Current Valuation Metrics and Market Dynamics

The valuation gap is further amplified by divergent economic fundamentals. The U.S. stock market, which accounts for 59% of global market capitalization despite representing only 21% of global GDP, faces headwinds from sector concentration. Meanwhile, international markets-particularly in Europe and Asia-are benefiting from cyclical and secular tailwinds. European banks, for instance, have outperformed U.S. mega-cap tech stocks over the past three years, driven by tighter monetary policy and improved credit conditions.

The MSCI ACWI ex USA Index's 18.1% return in the first half of 2025 highlights its growing appeal. This performance is underpinned by undervalued sectors such as energy, industrials, and consumer staples, which trade at or below their 20-year median forward P/E ratios. In contrast, the S&P 500's Information Technology sector, with a P/E exceeding 60x, reflects speculative excess reminiscent of the dot-com era as historical analysis shows.

Strategic Implications for Investors

For investors seeking long-term outperformance, international equity index funds offer three key advantages:

1. Diversification: By reducing reliance on U.S. mega-cap tech stocks, international indices mitigate concentration risk. The S&P 500's 60% premium to global markets as of June 2023 underscores the need for geographic diversification.
2. Valuation Arbitrage: International equities' 35% discount to U.S. stocks creates a compelling re-rating opportunity. Analysts project double-digit returns for European markets, where valuations are at 14x earnings compared to the U.S.'s 22x.
3. Macro Tailwinds: U.S. dollar weakness and tighter monetary policies in regions like Europe and Asia are fueling international equity gains. The FTSE Global All Share ex USA Index's 16.8x forward P/E in Q4 2025 suggests further upside as global economic fundamentals strengthen.

Conclusion

While the S&P 500 has dominated global markets for over a decade, its current valuation levels and sector imbalances signal a potential inflection point. International equity index funds, with their historical track record of outperformance during valuation corrections and their current discount to U.S. markets, present a strategic alternative. As global equities have already outperformed the S&P 500 by 2.7% in early 2025, investors who act now may position themselves to capitalize on a re-rating that history suggests is inevitable.