Why Are U.S. Stocks Trading at Such a Premium

Key Takeaways

• U.S. equities, while historically strong, currently trade at elevated valuations driven by tech concentration and robust earnings, making them significantly more expensive than international peers.
• International markets, after a standout 2025 performance, offer compelling diversification benefits and more attractive valuations, particularly in developed Europe, Japan, and select emerging markets.
• A weakening U.S. dollar and broadening global earnings growth are key tailwinds for international stocks, presenting a strategic opportunity for U.S. investors to rebalance portfolios.

Why Are U.S. Stocks Trading at Such a Premium?

U.S. equities have long been the darling of global markets, and for good reason. Since 2009, American stocks have outperformed their international counterparts in 12 out of 16 years, a testament to the innovation and economic dynamism within the U.S. economy. This sustained outperformance has, however, led to a significant valuation gap. Currently, U.S. stocks are trading at a substantial premium compared to global peers, a phenomenon largely driven by the dominance of a handful of mega-cap technology companies and their outsized earnings growth.

The concentration risk within the S&P 500 is stark. By the end of 2025, the 10 largest stocks accounted for more than 40% of the S&P 500’s market capitalization. This "Magnificent 7" effect has propelled U.S. market returns, but it also means that the overall index's performance is disproportionately tied to these few names. While these tech titans have delivered exceptional earnings, particularly fueled by the artificial intelligence (AI) boom, their valuations reflect this optimism, leaving less room for multiple expansion.

In contrast, non-U.S. stocks were recently about 35% cheaper than U.S. stocks based on forward price-earnings (P/E) ratios, even after their strong 2025 rally. This valuation disparity isn't just a fleeting trend; it reflects a fundamental difference in market composition and investor sentiment. U.S. Tech's heavy weighting in Semiconductors, over 40% versus just 8% for ex-U.S. Tech, has been a key driver of superior performance due to higher margins and pricing power. However, this also means U.S. markets face elevated valuations and concentration risks, complicating the investment landscape as we move further into 2026.

The narrative of "U.S. exceptionalism" has been powerful, but it's crucial for investors to recognize that high valuations inherently imply lower future returns if earnings growth doesn't keep pace. While Fidelity's Chisholm remains bullish on U.S. stocks for 2026 due to potential tax cuts, falling rates, and lower oil prices, the market is arguably in an "optimism phase" of a cycle that began in 2020. This late-cycle optimism typically sees rising valuations, but future gains are likely to be driven more by fundamental profit growth than by further multiple expansion.

Is the Tide Turning for International Markets?

Indeed, 2025 marked a significant shift, with international stocks staging a powerful comeback and meaningfully outperforming their U.S. counterparts for the first time in nearly 15 years. The MSCI ACWI ex USA, which tracks developed and emerging markets outside the U.S., surged by 26% in 2025, dramatically outpacing the S&P 500’s 15% gain. This wasn't merely a marginal victory; non-U.S. stocks returned 30% for the year, outperforming the S&P 500 by double digits and by nearly 15 percentage points.

This resurgence was not a fluke but rather a confluence of several powerful factors. A primary driver was the decline of the U.S. dollar, which weakened sharply in 2025, falling nearly 10% through September as measured by the U.S. Dollar Index (DXY). For U.S. dollar-based investors, a weaker dollar provides an additional tailwind to international returns, as foreign currency gains translate into higher dollar-denominated profits. This trend is expected to continue, with Goldman Sachs forecasting a shallower dollar descent in 2026, led by more pro-cyclical currencies.

Beyond currency effects, international markets benefited from a broadening of earnings growth and a "reversion to the mean" in valuations. While U.S. equities were largely driven by the earnings of a few large technology companies, outside the U.S., there was a more even balance between improving earnings and rising valuations. European earnings are expected to deliver 10% growth for the first time since 2022, and positive earnings revisions are increasing globally, led by U.S. small caps. This cyclical rotation, with international stocks carrying a larger weight in cyclicals, suggests that the outperformance of value stocks over growth, seen since November 2025, could persist.

The attractive valuations of international equities, coupled with accelerating global growth and the potential for continued dollar weakness, position them for another strong year in 2026. Developed international equities are forecast to deliver 7% annualized returns over the next decade, compared to 5.9% for U.S. large-cap equities, according to Schwab. This compelling case for diversification extends beyond just returns, offering exposure to different economies, sectors, and regulatory environments, which helps manage risks associated with the highly concentrated U.S. market.

What Does a Weaker U.S. Dollar Mean for Investors?

A weaker U.S. dollar, as observed throughout 2025, is a significant development with profound implications for investors, particularly those looking to diversify globally. The dollar's decline, including a 13.5% depreciation against the euro and 6.4% against the yen through September, was driven by persistent structural pressures like rising U.S. debt burdens and a gradual erosion of the U.S. growth premium. This shift is not just a short-term fluctuation but likely signals a turning point in the dollar's long cycle of strength, though not necessarily the end of its global dominance.

For U.S.-based investors, a declining dollar acts as a powerful tailwind for international investments. When the dollar weakens, returns from foreign assets, denominated in local currencies, translate into more U.S. dollars, boosting overall portfolio performance. This makes it an opportune time to increase exposure to non-U.S. markets, not only because many are priced to deliver superior risk-adjusted returns but also because foreign-currency exposure now offers greater potential for appreciation against the greenback. A modest reallocation from U.S. to non-U.S. assets can both diversify portfolios and hedge against further dollar weakness.

Conversely, for investors outside the U.S., managing dollar exposure becomes critical. Given the global dominance of U.S. stocks, many international portfolios have significant dollar exposure. Hedging converts volatile exchange-rate movements into steadier returns driven by interest rate differentials. However, hedging costs vary widely; for instance, it can cost roughly 4% per year for investors in low-rate regions like Japan or Switzerland, while investors in higher-rate markets such as South Africa can earn positive hedge returns. A measured approach to currency hedging, balancing costs and diversification benefits, is therefore prudent.

While the dollar remains elevated despite its recent depreciation, it is far from "cheap." Among 34 major developed- and emerging-markets currencies, only nine are currently more overvalued than the U.S. dollar. This suggests that while the greenback has become relatively cheaper, it still trades at a premium versus most peers. This continued overvaluation, combined with expectations of sturdy global growth and more balanced returns, should weigh on the dollar, given its usual negative correlation with risk sentiment, reinforcing the case for international diversification.

Are Japan and Europe the New Value Plays?

Japan and Europe are emerging as compelling value plays, offering attractive opportunities for investors seeking diversification and growth outside the U.S. market. In 2025, Japan's Nikkei index surged by 24%, while Germany's DAX climbed 22%, both significantly outperforming the S&P 500. This strong performance was not merely a currency effect; Japan, Europe, and emerging markets outpaced the U.S. in local-currency terms as well, indicating fundamental improvements.

European markets, in particular, are trading at reasonable valuations, with earnings growth expected to accelerate. Europe's renewed infrastructure and defense spending, coupled with capital discipline, can add uncorrelated sources of returns to a global portfolio. Germany, for instance, is embarking on a massive fiscal stimulus plan, which could further boost economic activity and corporate earnings. These factors, combined with a cyclical sector orientation that benefits from accelerating global growth, make developed European equities an attractive proposition.

Japan, despite facing heightened policy uncertainty with a newly elected Prime Minister Sanae Takaichi, is also a bright spot. Japanese companies are enacting shareholder-friendly reforms, which could unlock significant value for investors. These reforms, often focused on improving corporate governance and capital allocation, are designed to enhance shareholder returns and attract foreign investment. Furthermore, Japan's exposure to the global AI supply chain, with companies like ASML benefiting from the AI trend, provides an additional growth avenue.

The valuation argument for these regions is strong. While the U.S. market's success has owed to "margin expansion" or price appreciation out of proportion to fundamentals, stocks outside the U.S. came into 2025 cheap. Even after their rally, developed markets like the United Kingdom and continental Europe continue to trade at reasonable valuations. This suggests that future returns are more likely to be driven by multiple expansion as valuations converge with the U.S., alongside steady earnings growth, offering a compelling entry point for value-driven investors.

Diversification Beyond the U.S.: Risks and Opportunities

Diversifying beyond the U.S. market presents both significant opportunities and inherent risks that investors must carefully consider. The primary opportunity lies in accessing more attractive valuations and broadening exposure away from the concentrated, tech-heavy S&P 500. International equities offer exposure to different economic cycles, sectors, and regulatory environments, which can help manage risks associated with the U.S. market's high concentration and elevated valuations. Schwab forecasts 7% annualized returns for developed international equities over the next decade, compared to 5.9% for U.S. large-cap equities, largely due to these valuation advantages.

Emerging markets (EM) also offer compelling diversification benefits and potential for higher growth. With EM stocks representing just 7% of global developed equity exposure, there's significant room for reallocation. China, for example, with its plentiful low-cost electricity, presents a differentiated, lower-valuation way to participate in the growth of AI. Other emerging economies like Brazil and Mexico also stand out. A weaker U.S. dollar typically benefits emerging markets, as it eases debt burdens and makes their exports more competitive.

However, international investing is not without its risks. Geopolitical tensions, such as rising EU-China tensions over industrial capacity and the ongoing US-China dynamic, can introduce volatility. Trade-restricting measures, which surged in 2025 with around 18,000 discriminatory trade measures introduced since 2020, can disrupt global supply chains and impact corporate earnings. Furthermore, international equities typically come with greater volatility than their U.S. counterparts, a risk for which investors expect to be compensated.

Currency fluctuations, while a tailwind when the dollar weakens, can also become a headwind if the dollar strengthens unexpectedly. Policy uncertainty, particularly in regions like Japan with new leadership, or in Latin America with a crowded electoral calendar, can also impact market sentiment. Despite these risks, the long-term benefits of a well-diversified global portfolio, grounded in attractive valuations and broadening earnings growth, strongly outweigh the potential drawbacks for investors seeking to optimize risk-adjusted returns in 2026 and beyond.

The Path Forward for Global Investors

The investment landscape for 2026 signals a pivotal moment for global investors. While U.S. equities remain robust, their elevated valuations and concentration risks demand a strategic re-evaluation of portfolio allocations. The compelling performance of international markets in 2025, driven by a weaker dollar and broadening earnings, highlights a clear opportunity for diversification.

Investors should consider increasing exposure to developed international equities in Europe and Japan, as well as select emerging markets, to capitalize on attractive valuations and uncorrelated return drivers. This rebalancing is not about abandoning U.S. markets, but rather about building a more resilient, globally diversified portfolio that can navigate evolving market dynamics and geopolitical shifts. The goal is to capture growth wherever it emerges, rather than relying solely on the U.S. market's past exceptionalism.

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