Insights
At Last, International Equity to the Fore
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Insight Article
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March 25, 2025
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At Last, International Equity to the Fore
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March 25, 2025
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At Last, International Equity to the Fore
At Last, International Equity to the Fore |
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Investors and corporate leaders are struggling to keep up with the pace of political events, which are largely orchestrated by the new Trump administration. More than ever, investors should take heed and re-examine a now engrained view that U.S. equities remain the only game in town. The U.S. is increasingly pursuing more isolationist economic and foreign policies. We believe this may create greater cohesion and cooperation among regions like Europe.
Why International Equity Now?
Rule 101 of portfolio theory highlights the importance of diversification. U.S. investors should avoid being over-exposed to concentrated risks in their equity allocations, whether that’s geographic, thematic, or individual stocks. For many investors, an allocation to international equity may provide improved diversification.
International equity markets as represented by the MSCI EAFE Index provide exposure to 21 developed market countries and various currencies and sectors, creating less individual position domination with over 700 companies. The top stock in the index accounts for 1.7%, and the top 10 constituents account for under 14% of the index weight. That compares to 35% for the top 10 constituents of the S&P500, with the Mag71 accounting for over 31% of the index2.
Potential attractive return opportunities are another good reason to consider allocations to international equity. Investors focused on historical economic performance, market returns, and messy politics may be missing the opportunity to invest in some of the world’s leading companies. U.S. investors should not confuse weaker economics and complex politics with an inability to access attractive return opportunities, especially in Europe.
Consider Germany, which has been dragged down for two years by ongoing recession. It has struggled due to the war in Ukraine which has caused an energy crisis that has led to turmoil in its industrial heartland. Despite this dim macro environment, the DAX Index of 40 major German blue-chip companies trading on the Frankfurt Stock Exchange has handsomely outperformed U.S. Equity (S&P 500) since January 2024 as shown below:
Additionally, the German government announced plans this month to reform the fiscal debt brake and create a special investment fund that would enable hundreds of billions of euros in investment. Chancellor-in-waiting Friedrich Merz plans a €500 billion infrastructure fund to invest in priorities such as transportation, energy grids and housing. This move represents a dramatic shift in Germany’s fiscal policy, which should provide a sizeable boost for the European economy and strengthen defence in response to Russia’s aggression and U.S. foreign trade policy changes.
Why Reallocate Now?
U.S. equities have been driving global equity returns for over a decade, largely due to the nation’s economic growth trajectory since the end of the financial crisis. In 2023 and 2024, the S&P 500 has returned 26.3% and 25.0% respectively. This phenomenal performance was initiated by falling inflation, followed by lower interest rates. At the same time, U.S. economic momentum remained robust and much stronger than in large international regions like Europe and China. Throughout this period, the artificial intelligence (AI) theme gained momentum and fuelled the surge in the U.S. technology sector, leading many U.S. investors to stay within the domestic market.
However, the potential for lower interest rates in the U.S. seems largely off the table in 2025, but not so in Europe. While inflation has stabilized in the U.S., tariff policies being implemented are inflationary, which is less of an issue in Europe or China. Lastly, investors are increasingly questioning the eyewatering spend on AI by the hyperscalers, large cloud service providers providing services such as computing and storage at enterprise scale. The imbalances in the S&P 500 have been well documented over the last few years, with the domination of eight U.S. technology companies. Most of these are now heavily reliant on AI paying off. These imbalances are much less perceptible in international equity markets.
The valuation differential between international and U.S. Equity remains one of the strongest arguments for considering an allocation outside the U.S., even with the outperformance seen so far in 2025. As shown in the chart below, currently, international equity markets trade close to a 30% discount compared to domestic shares, so a re-rating of multiples could be the quickest way for these stocks to appreciate.
While many drivers behind a more constructive outlook on the merits of an allocation to international equity are macro related, our confidence is built from the bottom up, through a stock picker’s lens. At the heart of our investment approach is a commitment to investing in sustainable business models as the mechanism to compound assets for our clients.
As we await the outcome of events and their impact on the global economy and equities in 2025, we recall this phrase from risk management expert Nassim Taleb which captures our approach to investing: “invest in preparedness and not in prediction.”
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Managing Director, Co-Head of Eaton Vance Equity
Eaton Vance Equity Global Team
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Managing Director, Co-Head of Global Team
Eaton Vance Equity Global Team
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