Is the Party No Longer in the USA?

The current volatility has domestic equity markets on edge. Many U.S. equity asset classes and sectors are in negative territory so far this year. One unexpected bright spot in 2025 has been international equities, including emerging markets.

For the last decade, U.S. equity indices, such as the S&P 500, have outperformed international indices such as the MSCI EAFE Index. This year has been different. The developed foreign stock MSCI EAFE Index is up 11.45% while the S&P 500 index that tracks U.S. stocks is down 5% year to date. The MSCI EAFE index has also been stronger than the S&P 500 index for the last rolling year (April 29, 2024, to April 29, 2025).

Over the past decade, emerging markets have been a volatile place to invest, to say the least, even more so than the developed international sector. Stocks in the MSCI Emerging Markets and the MSCI EAFE indices are inexpensive despite the recent rally, currently trading at lower valuations than U.S. stocks in the S&P 500 Index.

The questions we must ask ourselves, despite the recent positive returns of international assets, is whether foreign markets will continue to move higher? And if so, will it be because their economies are growing, or because of anxiety in the American stock market? U.S. equities have led global stock returns for the last decade, largely due to the U.S. economic expansion since the 2008 financial crisis. This growth was aided by tailwinds of low inflation and historically rock-bottom interest rates. During that time, U.S. economic momentum remained strong and much healthier than other parts of the world like Europe, Asia and Latin America. During this period, the U.S. experienced surges especially in equity sectors such as technology (largely due to the growing interest in artificial intelligence), consumer discretionary, defense, communication services, and industrials.

Is the current interest rate environment a catalyst for international equities for the future? The Fed so far this year has held off on any significant rate cuts. In other words, the potential for lower interest rates in the U.S. appears off the table for now. Inflation seemed at bay in the U.S., but current tariff policies are inflationary, which may force the Fed to keep rates higher for longer. Tariffs are not an issue in Europe and other foreign markets. In April, the European Central Bank decided to lower the three key interest rates by 25 basis points due to lower inflation. Global central banks may follow suit due to lower inflation and slower economic growth.

If monetary policy is becoming less restrictive around the world, this should ignite growth, helping returns of foreign stocks.

There are many ways you can gain international and emerging markets exposure to your portfolio: actively managed mutual funds, exchange traded funds (ETFs) and American Depositary Receipt (ADRs) are the more direct and liquid options. The selection of U.S. registered funds devoted to foreign stocks is vast, below are a few variables to consider when choosing an international fund:

a) Fund Expenses or Expense Ratio: This is how much you are paying to the manager of the fund. International funds tend to have higher management fees than their domestic counterparts. This is particularly true for actively managed funds, as international markets generally require more specialized resources such as in-depth regional specific research and analysts, which translates to a more costly overhead in general than domestic funds.

b) Historical Performance: Over the past ten years, the S&P 500 Index has averaged 12.19% in annualized returns while the MSCI EAFE Index averaged 5.83%. The MSCI Emerging Markets Index has only averaged 3.29% for the past decade. Historically, international indices have trailed their domestic counterparts, but that could be different going forward.

c) Taxation: Qualified foreign dividends are generally taxed at higher rates than U.S. dividends, but potentially lower rates than U.S. taxable bond interest. Foreign dividends collected by U.S. residents are first taxed in the payer’s home country and then by the U.S. If your international fund is held in a taxable account, you can generally recover some or all the foreign tax via a credit on your tax return. If the foreign stock fund is in a tax-deferred or tax-free account, such as an IRA or a Roth IRA, the foreign tax paid is not recoverable. However, the tax credit benefit may not be significant enough to limit international investments solely to taxable accounts.

For most of the last decade, we have maintained an underweight to foreign investments relative to our target allocation. Given the current economic environment, it is worth reviewing current portfolio allocation targets to ensure they align with your goals and risk tolerance. Generally, we may consider ten percent as a base allocation to diversified international assets. As always, if you have questions, we are here to answer them.  Feel free to reach out.

Source: FactSet April 29th, 2025.

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