Thinking Globally: Reconsidering an allocation to international equities

Mike Cornacchioli, CFA, FRM, Senior Vice President, Investment Strategy Director

Throughout the years, global equity markets have experienced shifts in leadership, transitioning from one region to another (see Figure 1). As we closed out the calendar year of 2024, U.S. equity performance was enjoying an extended period of relative outperformance. This trend has led to a perception that international equities are less attractive, prompting many investors to reduce their exposure. However, as the first quarter of 2025 unfolded, investors witnessed a drawdown of U.S. equities as international markets experienced an unexpected resurgence. Within this investment article, we take a closer look at the historical formation of market cycles, potential catalysts for change in regional equity market leadership, and how investment opportunities may arise during these points of transition.

Historical performance cycles

Regional stock markets experience cyclical shifts shaped by macroeconomic conditions, monetary policy and investor sentiment. Although U.S. equities have outpaced non-U.S. equity markets over the recent past, there have been notable periods when international markets outperformed. Understanding some of these historical patterns help illustrate how different economic environments can impact regional equity returns.

1980s: Japan’s economic prosperity
In the 1980s, Japan achieved remarkable economic growth, contributing to sizeable outperformance of international equities. This impressive expansion was fueled by a manufacturing sector emphasizing efficiency, quality and innovation, putting it ahead of most developed economies at the time. Japan’s robust export economy thrived admist rising global demand for its products. Facing the impact of a strong yen, monetary policy and aggressive interest rate cuts implemented by the Bank of Japan in the mid-1980s sparked a credit boom, leading to further industrial and real estate development. At the pinnacle of this growth cycle in the late 1980s, Japan’s stock market accounted for nearly half of the global market capitalization. Rampant speculation led to an asset bubble that burst in the early 1990s, triggering a prolonged period of economic stagnation and Japanese equity market underperformance.

Early 2000s: The emerging markets and commodities boom
Following the U.S. dot.com burst in the early 2000s, international equity markets experienced exceptional growth, fueled by a surge in emerging markets amidst a global commodities boom. The Federal Reserve’s interest rate cuts weakened the U.S. dollar. At the same time, emerging economies underwent rapid industrialization. China’s entry into the World Trade Organization in 2001 expanded global trade and increased demand for raw materials, further fueling a commodity super cycle. Rising oil, metal, and agricultural prices benefited resource-rich emerging economies like Brazil, Russia, India and China. The era of international outperformance abruptly halted following the 2008 Global Financial Crisis, severely impacting leveraged economies reliant on commodity exports and external financing for economic growth.

Key drivers of international equity Outperformance

Several factors have contributed to international equity outperformance relative to U.S. markets through historical market cycles. Understanding these dynamics and how they relate to the current environment can help investors identify potential investment opportunities.

Monetary policy and a weaker U.S. dollar Currency valuation and central bank policies are a critical determinant of market leadership. A weakening U.S. dollar has historically served as a tailwind for international equities. Prolonged dollar depreciation in the late 1980s (post 1987 U.S. stock market crash) and early 2000s (dot-com bubble) coincided with significant international outperformance. A weaker dollar enhances financial conditions within emerging economies, reducing import costs and easing the burden of servicing dollar-denominated debt.

In recent years, the U.S. dollar has strengthened against most major currencies, as the Federal Reserve has aggressively raised interest rates, prompting concerns that the currency may be overvalued. One measure to gauge the dollar’s valuation is to analyze the broad real effective exchange rate (REER),* which measures the value of the home currency to that of its trading partners (see Figure 2). When the REER Index exceeds 100, it suggests that the home currency may be overvalued, indicating the dollar is currently overvalued by approximately 13 percent. While dollar strength may persist, a reversal of this trend could be a meaningful indicator for potential international equity market gains.

Stronger economic growth abroad

Periods of international equity outperformance are often linked to more substantial economic growth outside of the United States. A robust economy boosts consumer confidence, spending and corporate earnings, attracting investor capital furthering the appreciation of the respective currencies. The economic boom in Japan during the 1980s and the rapid expansion of emerging markets in the early 2000s illustrate this trend.

When foreign economies lead global growth and propel regional equity markets higher, international equities tend to benefit from their unique economic compositions compared to U.S. markets (see Figure 3). International developed and emerging markets have greater exposure to cyclical sectors, which among other factors are strongly correlated to the overall health of the global macroeconomic environment. By contrast, today the U.S. market leans more toward growth sectors such as technology and consumer discretionary, which have the ability to reward investors during both slow but stable economic expansions where interest rates tend to be lower, as well as in high-growth phases of the economy. It is also important to keep in mind that sector weightings within major indices will change over time depending on themes and trends driving economic growth. For example, financials were a significantly larger contributor to U.S. GDP and hence a larger weighting in the U.S. leading up to the financial crises.

For years, U.S. economic growth has outpaced other developed economies by a wide margin, reinforcing the notion of “U.S. exceptionalism.” However, this trend could reverse under certain conditions. A monetary policy misstep by the Federal Reserve, such as keeping rates too high for too long or cutting them prematurely, could dampen U.S. growth. The potential for policy shifts related to trade, immigration, government spending — and of course tariffs — could also curb economic potential.

Market valuations

Market leadership can potentially shift when valuations reach extreme levels. When market sentiment sways too far in one direction, contrarian value opportunities emerge, setting the stage for lagging sectors or markets to catch up. History offers clear examples. Japan’s price-to earnings ratio peaked near 60 times earnings in 1989, before collapsing and ceding market leadership. The United States hit a high of 32 times earnings in 1998, before suffering a sizeable correction. Valuation extremes and variances between regions can persist for extended periods, making them unreliable as a short-term timing mechanism. However, over the long run, markets tend to revert to the mean with valuations moving closer toward historical trends. Today, U.S. equities trade at the highest valuations globally, driven by superior earnings growth (see Figure 4). However, premium valuations can be vulnerable to (price-earnings) multiple compression should investor sentiment shift. In contrast, today, both developed and emerging markets trade at significant discounts to U.S. equities, more closely aligning with historical norms. While this valuation dynamic has persisted for several years, disparities in corporate earnings growth rates are forecast to narrow, based on consensus analyst estimates. Alongside other structural shifts, positive shift in earnings expectations for international markets could also narrow the premium that investors place on U.S. equities.

Portfolio considerations: Rethinking international equity allocations

The sustained outperformance of U.S. equities has reshaped the global investment landscape. At the start of 2025, U.S. equities represented over 65% of the MSCI All Country World Index (ACWI), up significantly from 40% in 2010 (see Figure 5). Given the scale of this shift, reassessing portfolio allocations is prudent. Investors typically exhibit a home bias, preferring to allocate more to their domestic market. Consequently, their exposure to U.S. equities may be even higher than they realize. While the U.S. home bias has been a winning strategy, concentration risk has been further compounded due to the significant outperformance of mega-cap technology stocks.

We are of the view that a disciplined investment strategy should use global market capitalization weightings as a guide when constructing a well-diversified portfolio. Under this approach, the equity portion of an investor’s portfolio would allocate about two-thirds to the United States and one-third to international markets, split between developed and emerging equities. A globally diversified approach enhances resilience across economic cycles and reduces reliance on the health of a single market or economy. This positions investors for a more balanced risk-reward profile, whether U.S. dominance persists, or a new chapter of international market leadership unfolds.

Conclusion: The case for global diversification

We are of the view that investors who stay diversified and attentive to valuation imbalances will be best positioned to capitalize on shifting global market dynamics. History suggests that over time undervalued markets can eventually become tomorrow’s leaders. Market leadership has historically rotated between U.S. and international equities, often driven by economic conditions, currency trends, and sectoral shifts. Japan’s dominance in the 1980s and emerging markets’ surge in the 2000s illustrate how shifting global cycles may play out in the future. Today, despite their recent move, higher international markets offer compelling valuation opportunities relative to large capitalization U.S. equities. Recently we have seen how non-U.S. equity markets, most notably in Europe, have benefited from a lower central bank policy rate and a weaker currency relative the U.S. dollar. These points, plus cheaper valuations and structural developments, with regards to a sizeable increase in defense spending, have propelled regional markets in the Eurozone to multi-year highs. At the same time, we continue to see continued strength and investor interest in Japanese equities, as well strength in a number of emerging markets. However, a key missing element remains as we question the durability of an international rally, and as we contemplate if relative economic growth across the region and abroad is sustainable.

About the author

Michael Cornacchioli is Investment Strategy Director and a key member of the firm’s Investment Strategy Group. In this role, he spearheads macroeconomic research, formulates asset allocation recommendations, oversees manager selection and constructs portfolios. His expertise also extends to managing the firm’s U.S. Large Cap Equity strategy, ensuring robust performance and strategic growth.

With over two decades of experience in investment and wealth management, Michael has a proven track record of working with high net-worth individuals and institutional clients. Before joining Citizens in 2015, he honed his skills at Commonwealth Financial Network an Weston Financial Group, where he held similar influential roles.

Outside of his professional life, Michael resides in the vibrant city of Charlotte, NC. He is an avid golfer, rock climber and cyclist, always seeking new adventures. Above all, he cherishes spending quality time with his family, balancing his career with a fulfilling personal life.

Michael is a CFA® Charterholder and a Certified Financial Risk Manager, actively participating in the CFA Institute, and the Global Association of Risk Professionals.