US and International Equities: A Narrowing Gap?

Core Insights - There has been a significant divergence in performance between international equities and US equities over the past year, with international equities outperforming US equities, marking a shift from the previous decade [1][2] - The outperformance of EAFE stocks in 2025, with returns of +31.6% compared to +17.7% for the S&P 500, raises questions about whether this trend is cyclical or structural [2][4] Performance Analysis - From 2013 to 2022, US equities outperformed EAFE stocks, compounding at 15.2% versus 7.1% [2] - EAFE stocks entered 2025 at deeply discounted valuations, with a forward P/E below its long-term median, while the S&P 500 remained elevated at approximately 22x forward earnings [14] Sector and Geographic Insights - EFA tracks large- and mid-cap stocks across 21 developed markets, with Japan being the largest country weight at roughly 22% [6] - The primary drivers of EFA's +31.6% return in 2025 included a weakening dollar, a rally in Financials, and a surge in the Industrials sector due to Europe's rearmament [7][10] Earnings Growth Projections - Consensus forecasts for 2026 suggest S&P 500 earnings growth of approximately 13-14% and EAFE earnings growth of 10-11%, indicating a potential narrowing of the earnings growth gap [15] - Historical data shows that EAFE has often entered years with optimistic earnings forecasts but has fallen short, making the 2026 earnings outlook particularly noteworthy [15] Market Dynamics - The distinction between domestic and international exposure is less clear, as S&P 500 companies derive a significant portion of revenues from outside the US, while EAFE constituents are more reliant on their home markets [20] - Both markets appear to have legitimate tailwinds heading into 2026, suggesting that the conditions driving their divergence may be normalizing rather than reversing [17]