Shiller's Forecast vs. the 2026 Reality: Can International Stocks Outperform?

The case for international stocks hinges on a stark valuation divergence, a point underscored by Nobel laureate economist Robert Shiller's latest forecasts. His cyclically adjusted price-earnings (CAPE) model, which smooths earnings over a decade to gauge long-term value, paints a picture of U.S. markets trading at extreme premiums while international prospects appear more favorable. The core thesis is structural: with the S&P 500's CAPE ratio above 40, a level only seen at the dot-com peak, the model predicts a decade of subdued returns for U.S. equities. Shiller's forecast for the S&P 500 is for average annual nominal returns of just 1.5% over the next decade. This outlook is built on the premise that prices have climbed far faster than earnings, leaving little room for further multiple expansion and setting the stage for potential compression.

Contrast that with the outlook for developed international markets. Shiller's model sees European stocks as a brighter long-term bet, forecasting average annual returns of 8.2%. Japanese stocks are also viewed more favorably, with a projected annual return of 6.5%. The gap between these forecasts and the U.S. outlook is the central investment argument. It is built on the premise that U.S. valuations are extremely rich compared to the historical norm, while international markets, even after a strong 2025 rally, still trade closer to their own long-term averages. This isn't a short-term trade call but a bet on mean reversion in valuations, where the starting point for international investments offers a more compelling risk-reward setup.

The 2025 Pivot: Momentum Meets Valuation

The Shiller forecast for international stocks is now being tested by a powerful, real-world shift. In 2025, the long-awaited rotation from U.S. to global equities delivered a spectacular, broad-based rally. The MSCI All Country World ex-USA index gained 29.2%, handily outpacing the S&P 500's 16.4% gain. This wasn't a niche move; it was a comprehensive re-rating. The artificial intelligence boom fueled surges in Asia, with South Korea's benchmark index soaring nearly 76% and Japan's Nikkei 225 up 26%. European markets also rallied on improved growth prospects and defense spending plans. A weaker U.S. dollar provided a tailwind, making foreign assets more valuable for dollar investors.

This performance marks a decisive break from a brutal decade of underperformance. For years, global equities outside the U.S. lagged badly, with one major benchmark underperforming domestic markets by about 60% over ten years. That gap shaped investor behavior, concentrating capital in mega-cap U.S. tech and creating a structural underweight. The 2025 rally has erased that deficit, with international equities beating the S&P 500 by roughly 15% since the inflection point in late 2024.

The question now is whether this is a sustainable shift or a cyclical peak. The momentum is undeniable, driven by concrete catalysts like AI demand and fiscal stimulus. Yet the sheer magnitude of the 2025 move raises a critical question for the Shiller thesis: has the valuation gap closed? The model's forecast for Europe at 8.2% annual returns and Japan at 6.5% implies significant room for further appreciation. But if international stocks have already climbed 30% in a single year, much of that optimistic path may now be priced in. The pivot is real, but the sustainability of the outperformance will depend on whether the fundamental earnings growth can keep pace with the elevated expectations.

The 2026 Engine: Growth, Policy, and the Dollar

The momentum from 2025 is being fed by a confluence of macroeconomic and policy forces that could sustain international outperformance. The most persistent tailwind remains a weaker U.S. dollar, which fell roughly 9.4% in 2025. This depreciation, the worst annual drop since 2017, continues to benefit dollar investors in foreign assets by making them more valuable upon conversion. The trend is supported by divergent monetary policies, with the Federal Reserve maintaining a higher-for-longer stance while other central banks, particularly in Europe, have begun cutting rates. This dynamic provides a structural boost to international returns that is independent of local earnings growth.

Policy initiatives are adding a powerful, targeted layer of support. In Europe, Germany is embarking on a massive fiscal stimulus plan, a direct response to its recent economic stagnation. This unprecedented government spending, coupled with broader defense budget increases across the continent, is designed to stimulate domestic demand and improve growth prospects. The effect is already visible in the rally of European markets, which received a "boost from plans for government spending on defense and improved prospects for economic growth" last year. These are not abstract policy promises but concrete catalysts that can translate into higher corporate earnings and justify elevated valuations.

Yet the most critical question for 2026 is whether these growth and policy tailwinds can outpace the elevated starting point for international stocks. The global CAPE ratio, a key metric for long-term valuation, now stands at 27.71 as of January 1, 2026. This figure is above its long-term historical average and indicates that global equities, as a whole, may be overvalued relative to historical norms. This is a significant development for Shiller's forecast, which implies substantial room for further appreciation in markets like Europe and Japan. The elevated global CAPE suggests that the easy gains from a pure valuation reset may be behind us. The path forward now hinges on earnings growth keeping pace with these higher prices.

The setup is one of competing forces. On one side, a weakening dollar and targeted fiscal stimulus provide a clear, near-term tailwind. On the other, the market's overall valuation has climbed, limiting the upside from a simple mean reversion. For international stocks to continue outperforming, the growth engine must accelerate. The JPMorgan Global Manufacturing PMI shows signs of resilience, with business optimism rising to a five-month high. If this translates into sustained profit expansion, it could validate the current prices and extend the outperformance. But if growth disappoints, the elevated valuations could quickly become a liability.

Catalysts, Risks, and the Path to 2027

The sustainability of the 2025 shift now depends on a handful of forward-looking catalysts and vulnerabilities. The path to 2027 will be determined by whether global growth can accelerate to justify current valuations, or if the U.S. market reasserts its dominance, or if political storms disrupt the fragile consensus.

The most potent near-term catalyst is the lagged effect of global monetary and fiscal easing. Central banks, particularly the European Central Bank, have cut rates aggressively, with the ECB delivering a 235 basis point easing cycle from June 2024 to June 2025. Historically, these cuts take about nine months to boost manufacturing activity, a key leading indicator. With the JPMorgan Global Manufacturing PMI showing business optimism at a five-month high, the delayed impact of these rate cuts could fuel a genuine acceleration in global economic growth through 2026. This would provide the fundamental earnings growth needed to support international stocks and validate the Shiller thesis. Germany's massive fiscal stimulus plan adds a powerful, targeted layer of support, directly stimulating demand in a key European economy.

Yet the dominant counter-force is the potential resurgence of U.S. market dominance. The AI-driven earnings boom is not confined to international markets. Analysts project 14% to 16% annual EPS growth for the S&P 500 in 2026, a pace that would double the growth for non-mega-cap stocks. If this forecast holds, the outperformance of the "Magnificent 7" tech giants could reassert itself, drawing capital back to U.S. equities and reversing the 2025 rotation. This scenario would directly invalidate the Shiller forecast, as it would demonstrate that U.S. valuations can still be supported by exceptional earnings growth, not just mean reversion.

The most unpredictable variable is the mounting political and geopolitical risk. Domestically, a shift toward populist affordability politics could pressure corporate earnings and investor sentiment. Abroad, geopolitical flashpoints-from U.S. intervention in Venezuela to civil unrest in Iran-add layers of uncertainty. These are not abstract risks; they can disrupt supply chains, alter trade flows, and trigger volatility that disproportionately affects international portfolios. The recent tariff turmoil has already shown how policy shocks can disrupt the transmission of monetary policy to the real economy.

The bottom line is one of competing narratives. The Shiller thesis for international stocks rests on a valuation gap and a global growth acceleration that is just beginning to materialize. The alternative narrative is a resilient U.S. earnings engine and a complacent market that leaves little room for error. The path to 2027 will be defined by which story gains traction first. For now, the catalysts are in place for a strong year, but the risks are equally potent.