Is It Time To Go Abroad?
Will US Equity Outperformance Continue?
I’ve been getting asked a lot recently what I think about US equity outperformance (US stocks performing better than non-US stocks) over the past decade, and whether this will persist or whether it will reverse. Antti Ilmanen at AQR has already weighed in on this question, and he definitely has a more robust answer than I do, so let’s take a look.
Exceptional Expectations: U.S. vs. Non-U.S. Equities
A Brief Antti Ilmanen Sidebar
My first exposure to Antti Ilmanen came when I was a student at Universidade Federal do Rio de Janeiro’s business school. We read his paper on shifting stock-bond correlations, which came to the conclusion that changes in fundamental economic conditions (growth, inflation, risk premiums) affect stocks and bonds — and by extension their correlations — in different ways. Without realizing it, this was my first exposure to the idea of balancing a portfolio across different economic environments, an idea that would become increasingly impactful in my subsequent career. I’ve been a fan ever since. So much so, in fact, that his book Expected Returns is one of four that I keep on my desk (the other three are two volumes of the CAIA Curriculum and the novelization of the 1986 film Big Trouble in Little China).
To start, let’s jump to the attribution of what is happening.
The dark blue line is the total outperformance of US stocks over non-US stocks. It is the sum of all the other lines on the chart, which are the components of that outperformance. The things I find most interesting about this chart are:
US earnings growth outperformance has been a consistent contributor to outperformance (royal blue line) - Part of the reason that US stocks have done better than non-US stocks is because US growth has been better than non-US growth. This is a real, fundamental explanation that we can feel good about.
The US valuation differential is at an extreme level (pink line) - The difference between US and non-US valuations (the Price/Earnings ratio) is pretty much the highest it’s ever been. These things can always move to even more extreme levels, but at some point they reach a limit. This is even more of a contributor to the US equity outperformance than the growth differential.
The growth differential and the valuation differential are moving in different directions - The pink line continues to climb higher, while the royal blue line is moving down. This means that the rest of the world’s growth performance is catching up with the US while investors are still valuing US stocks like they’re the only game in town.
With US outperformance at pretty extreme levels, driven by pretty extreme valuation differentials, it’s worth considering how this could sustain itself. Ilmanen writes:
The higher the relative valuations become, the harder it is to satisfy the high (relative) growth expectations embedded in them. At some point, only a small catalyst can shift sentiment, and this may already have happened in 2025. But it’s important to remember that these valuation-based predictions are more useful for the next 5-10 years than for the next year. Shorter-term predictions need a catalyst besides a value based signal. The Fed has historically been the commonest catalyst to prick bubbles or growth stock booms, but other possibilities exist and have already moved markets in 2025: regulation, competition, sentiment, and geopolitics. Notably, the new administration’s policies have raised tariff-related uncertainty and the risk of stagflation in the US.
It doesn’t take much to see this process reverse. It’s also worth noting that these relative returns are in currency hedged terms; as we talked about yesterday, the value of the dollar has already fallen about 10% in 2025, and the outlook is for it to fall even more. While I’m a big believer in betting on the thing you actually want to be betting on — meaning if you want to take a position in equities you should hold it currency hedged so you’re not also taking an FX position — the reality is that many investors do not do it this way, so get currency exposure in their equity allocations. For these investors, the relative underperformance of US equities in 2025 has been even starker due to the currency moves.
I’ll leave to conclusion to Ilmanen:
The outperformance of US equities over Non-US during the past 35 years mainly reflects relative richening, as US market valuations rose from roughly half Non-US to double Non-US. Equity investors tend to extrapolate past growth and past returns, and post-GFC US outperformance has been exceptionally consistent. It may be fair to extrapolate some growth edge (say, 1% p.a.) because the US has enjoyed such an edge over long histories, and today’s AI tailwinds may well justify a continued edge. However, markets seem to expect even more. We suspect that few investors appreciate how much of the past absolute and relative performance reflects repricing, which really should not be extrapolated – especially when today’s extreme valuations point the other way. Rearview mirror expectations may be strongest just when they are most dangerous.
While almost anything could happen in the near term, over a multi-year horizon we echo Asness (2025) in asking even US bulls to consider whether it’s possible that US overvaluation >> US exceptionalism.
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