With investor focus now squarely back on U.S. equities as new all-time highs are in sight, we dig into why strategic allocations should still consider, despite recent outperformance and multiple expansion, diversification into international equities. Using a five-factor attribution analysis, we analyze the drivers of returns for U.S. and non-U.S. equities over the last quarter century, with a particular focus on what drove the U.S. to outperform non-U.S. equities so dramatically over the last 15 years. We then use that same analytical framework to create an illustrative scenario analysis to determine potential returns to U.S. and non-U.S. equity markets, showing why starting valuations matter—when looking far into the future.

U.S. (Equity) Exceptionalism — We Are So Back! (Right?)

The S&P 500 continues its ascent up the proverbial “wall of worry” toward fresh all-time highs (as of June 26, the large cap index closed three points away from the February 19 high), and investors are keen to hit the beach as we approach the 4th of July holiday. The debate over whether large cap U.S. stocks remain “exceptional” relative to their small cap and international peers has taken a back seat in recent weeks to geopolitical and macroeconomic headline risk; those risks have cleared (so we’re told, and for the time being), and U.S. equity markets sure feel exceptional. While there are signs and catalysts that small caps are ripe for a catch-up trade this summer (short positioning, that Big Beautiful Bill, trade deals, monetary policy changes), this week we are digging into the U.S./non-U.S. equity “exceptionalism” debate.

The MSCI USA Index (similar construction as the S&P 500, and what we will use to represent U.S. stocks) has outperformed the MSCI World ex USA Index (an index of developed non-U.S. equity markets, and what we will use to represent foreign stocks) by 4.5% points since markets troughed earlier this year on April 8. Recent U.S. outperformance notwithstanding, the non-U.S. index remains ahead of the U.S. index by ~11% year-to-date heading into the end of the first half of 2025. If that lead holds, this will mark just the fourth year in the last 16 (looking back to 2010) that developed non-U.S. stocks outperformed U.S. stocks. The question on investors’ minds is whether this is the start of a longer-term trend: a reversal of U.S. equity exceptionalism? Or just a mean-reverting aberration year?