In a changing global economy, non-U.S. equities begin to stand out

In a year of many surprises for financial markets, one of the biggest may be the rally in non-U.S. stocks. While the S&P 500 Index is up little more than 2% year to date in 2025, the MSCI All Country World Index ex USA has gained 16% – a sharp reversal of recent past performance for the indices.^[i]

What’s more, there are signs ex U.S. equities could have more to gain, thanks to still-attractive valuations and structural changes resulting from Trump administration policies. For investors – many of whom started 2025 overweight U.S. stocks – these signs may be worth heeding.

Outside the U.S., a renewed focus on growth

In recent years, non-U.S. equities have sometimes started off the calendar strong, only to see their gains eventually trounced by high-growth U.S. peers. But increasingly, there are reasons to believe that pattern might break.

For one, shifting trade policies and geopolitical tensions are leading more governments to roll out fiscal stimulus. Defense spending in Europe, for example, has been rising since the Russia-Ukraine war began in 2022 and could be set to dramatically increase following a NATO summit in late June, when European countries could pledge to lift defense spending to between 3.5% and 5% of gross domestic product (GDP), up from an average of about 2% today. That spending could also have a multiplier effect on Europe’s GDP as hiring and capital investment ramp up. Indeed, in March, Germany voted to relax its “debt brake” for defense spending and earmarked €500 billion (~11% of GDP) for infrastructure projects over the next 12 years. More broadly, we are seeing new and increased urgency from leaders such as Mario Draghi, former European Central Bank (ECB) president, and Ursula Von Der Leyen, president of the European Commission, pushing the case for increased competitiveness of European firms via consolidation and innovation.

China, meanwhile, has been rolling out stimulus packages to revive domestic consumption and raised its fiscal deficit target this year to 4% of GDP, up from 3% in 2024. Furthermore, in pursuit of technology independence, Beijing is starting to show more support for its private-sector tech companies. That includes the announcement of a 1 trillion yuan ($139 billion) state-backed venture capital fund to help advance artificial intelligence and expanded credit resources for tech- and science-focused companies.

A supportive backdrop for stocks

These policy changes are occurring at the same time financial market conditions are also shifting. On a price-to-earnings basis, U.S. stocks trade at a significant premium to ex U.S. peers (Exhibit 1). Additionally, uncertainty around tariffs and the credit worthiness of U.S. debt has put upward pressure on long-term Treasury yields, further limiting U.S. stocks’ relative attractiveness.

Trump administration policies have also complicated the outlook on U.S. inflation and, consequently, the Federal Reserve’s ability to lower interest rates. By contrast, other major central banks have been loosening monetary policy. This month, the ECB cut rates for the eighth time in a year, bringing its policy rate down to 2% – more than two percentage points lower than in the U.S. And last month, China’s central bank lowered several of its benchmark lending rates, part of monetary easing shift that began in 2024.

Staying mindful of risks

Even as prospects for ex U.S. stocks improve, risks remain. Uncertainty around tariffs could slow the global economy. In its spring forecast, the European Commission lowered its growth outlook for the European Union to 1.1% for 2025. Last fall, it had projected 1.5% growth. The weakening of the U.S. dollar – which for now, has helped to prop up returns for investors in non-U.S. stocks – could also make the region’s exports less competitive and reduce earnings on a currency-adjusted basis.

Ongoing trade tensions have also weighed on China’s economy. In May, Chinese manufacturing activity fell into contractionary territory as exports slowed. Weak consumer demand and a prolonged property market downturn are further headwinds. And in Japan, GDP contracted from January to March, the first quarterly pullback in a year.

Opportunities for investors

Against this backdrop, we believe investors should be opportunistic about non U.S. equities – but selective. In our view, that means considering European defense and industrial firms that could benefit from increased government spending, particularly in Germany, where manufacturing capacity must be aggressively ramped up to meet defense goals. European banks also look well positioned. These companies have spent years building capital reserves that now are being returned to shareholders in the form of dividends and share buybacks. Prospects for banking-sector deregulation have also been rising amid a deregulatory push in the U.S., which could further boost profitability. Just this month, the ECB announced it would speed the process for approving bank share repurchases.

Conversely, we would steer investors away from companies with long supply chains, such as automakers, which we think face a wider range of outcomes from tariffs. As an alternative, investors might favor companies with subscription-based business models, which have minimal exposure to trade policies and therefore could prove more resilient in the current environment. Chinese Internet companies are also trading at some of the lowest valuations we’ve seen. We think these stocks could rerate higher should fiscal stimulus prop up domestic consumption (driving online ad spending) and government support for advanced technology continues. Finally, in Japan, select financial services firms could benefit as governance reforms drive capital markets activity such as divestures (which could continue irrespective of the macroeconomic backdrop) and rising wages and inflation revive demand for financial management services.

IMPORTANT INFORMATION

Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.