Equity Outlook: US vs. International

We recently released the results of our annual Capital Market Assumptions (CMAs), one of the key takeaways from this year’s process is that the range of potential outcomes for markets is expanding. The market volatility that we have experienced in early 2025 supports the notion that we are in the later stages of the economic cycle where uncertainty tends to permeate through markets. This is most evident in equity markets, where investors need to weigh elevated valuations against a backdrop that suggests a healthy business environment (despite trade-related uncertainty).

US Equity Valuations - Still High

As of the end of 2024, the Price-to-Cash Flow Ratio (our preferred measure of valuation) for the S&P 500 was 21.8x, in the 98th percentile of its historical range. Even during the selloff in early April, that ratio only got as low as 17x (85th percentile), suggesting that further normalization is likely to occur over the coming years. As illustrated in the table below, such normalization is likely to lead to lower expectations for future returns.

However, there is much that could be said to justify structurally elevated valuations relative to history. GDP consistently surprised to the upside and capital expenditures pushed investment spending to post tech bubble highs, primarily as a result of the artificial intelligence (AI) buildout. Profit margins for US companies are also close to 12% and the forecast for EPS (earnings-per-share) growth remains positive. In fact, profit margins are now 65% higher than they were 20 years ago, which allows companies to command higher multiples. Most of all, we are now approaching the point where the substantial investments made in AI are able to be potentially monetized, and the result could be a significant boost to productivity.

Looking ahead, capital markets face a wider range of potential outcomes, shaped by a complex mix of opposing forces. This is reflected in the wider dispersion of forecasts across various asset classes and reflects a tempering of enthusiasm – suggesting that the future may look quite different from the recent past. Elevated valuations and heightened economic and political uncertainty may weigh on returns, while strong fundamentals, robust profitability, and the potential for significant productivity gains provide reasons for optimism. Navigating this environment will require a patient and pragmatic approach where diversification is likely to play a more important role.

The Increasing Importance of Global Diversification

For many years, clients consistently asked about the value of maintaining a globally diversified portfolio. US equities comfortably outperformed international equities over the past 15 years, and for most of that time, US bonds offered a better combination of yield and stability. The outperformance of US assets was largely driven by the relative strength of the US economy and the historically high profitability of the US tech sector, which helped US equity markets produce better earnings growth.

Over time, the consistent outperformance – both in terms of price and fundamentals – led to questions about the viability of owning non-US stocks, even as relative valuations became increasingly difficult to ignore. Entering 2025, US equity valuations were in the 96th percentile relative to a broad basket of international stocks, as measured by the MSCI EAFE Index.

Over time, the consistent outperformance – both in terms of market returns and fundamentals (ie. earnings) – led to questions about the viability of owning non-US stocks, even as relative valuations became increasingly difficult to ignore. Entering 2025, US equity valuations were in the 96th percentile relative to a broad basket of international stocks, as measured by the MSCI EAFE Index.

From a valuation standpoint, international equities present an opportunity—but capitalizing on it requires investors to shift their mindset and move beyond the ingrained bias shaped by over a decade of U.S. dominance. Such a change in mindset can be difficult, but it is worth considering that the primary drivers of US equity outperformance in recent periods are beginning to fade.

International markets are also showing signs of improved earnings growth (though nowhere near the levels seen in the United States) and fiscal stimulus packages are increasingly likely, especially in Germany. In Japan, corporate governance reforms are leading to share buybacks, which provides an additional tailwind for earnings growth to accelerate. But perhaps most significantly, the Trump Administration’s hardline stance on trade policy presents a potential sea change that could produce a shift in the demand dynamics for US-based assets.

For the vast majority of the post-World War 2 era, the US economy generally benefited from the shift toward globalization. As the richest nation in the world, the United States purchased goods from foreign markets, freeing up American labor capacity to be put to use in more productive ways (such as building out new technologies and innovations). In return, foreign market participants re-deployed the dollars they received from these transactions into US financial assets, such as stocks and bonds. This dynamic has resulted in a steady flow of capital into US markets for much of the past 60+ years (see figure below).

But it is possible that we are entering a transition period where the longstanding trend of globalization is reversed and replaced with a new world order that relies less upon comparative advantage and free trade. In such an environment, global diversification takes on increased importance because there is reduced interdependence across countries and markets.

This should not be construed as a long-term call for international equity outperformance (there remain a variety of fundamental factors that support continued strength in US markets), but the CMA process affords us the opportunity to think strategically about potential implications for portfolio construction. The current backdrop, which is rife with geopolitical and economic uncertainty, certainly presents a potential catalyst for a shift in equity market performance that could serve as a thematic driver of returns going forward. We would thus be remiss if we did not explore the idea. As highlighted below, the timing of these sorts of ebbs and flows can be very difficult to get right, which is why a long-term lens is required.

Summary

In an era of uncertainty, it's important to remain diversified with your equity exposure. US stocks have had a good run of form the last decade that have driven valuations up to a level that has historically meant muted forward looking returns. The rear-view for international stocks has not been as impressive but there is reason to be optimistic looking forward. International stocks are currently trading at a valuation discount compared to US stocks, earnings growth from foreign companies are improving, foreign governments are implementing more supportive economic policies and de-globalization could mean less money flowing into US assets from foreign investors in favor of their local economies and markets.

For more information on how we are investing amidst the current uncertainty check out the following:

Amid Heightened Uncertainty, Private Investments Can Play an Important Role
Bond Math Suggests Better Days Could be Ahead

Disclosures:

This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is considered to be reliable, Forty W Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. If the reader chooses to rely on the information, it is at reader’s own risk.

Past performance is no guarantee of future results. Different types of investments involve varying degrees of risk. Therefore, there can be no assurance that the future performance of any specific investment or investment strategy, including the investments and/or investment strategies recommended and/or undertaken by Forty W Advisors, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No amount of prior experience or success should be construed that a certain level of results or satisfaction will be achieved if Forty W Advisors is engaged, or continues to be engaged, to provide investment advisory services. you should not assume that any discussion or information contained in this presentation serves as the receipt of, or as a substitute for, personalized investment advice from Forty W Advisors. A copy of our current written disclosure Brochure discussing our advisory services and fees is available upon request or at www.fortywadvisors.com/disclosures. The scope of the services to be provided depends upon the needs and requests of the client and the terms of the engagement.

Please Note: Capital Market Projections/Forward Looking Statements/Material Limitations. Projections and forward-looking statements (the “Projections”) are not historical facts. The Projections in this presentation are subject to inherent limitations and qualifications and are based on a number of assumptions. The Projections involve risks and uncertainties, including statements as to: (i) general volatility of the securities markets; and, (ii) changes in governmental regulations, tax rates, interest rates and similar matters. The Projections are based on beliefs, assumptions, and expectations, taking into account currently available information, including historical data. These beliefs, assumptions, and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, actual performance could be materially different from the Projections. The Projections should not be construed or relied upon as an absolute probability that a different result (positive or negative) cannot or will not occur. To the contrary, different results could occur at any specific point in time or over any specific time period. The purpose of the projections is to provide a guideline to help determine which scenario best meets the client’s current and/or current anticipated financial situation and investment objectives, with the understanding that either is subject to change, in which event the client should immediately notify Forty W Advisors so that the above analysis can be repeated.

Please Further Note. Different types of investments and/or investment strategies involve varying degrees of risk and volatility, and at any specific point in time, or over any specific time-period, any investment or investment strategy can and will suffer losses, at times substantial losses. Positive performance should be considered secondary. The purpose of this presentation is to help you to determine if you are willing and able to accept the volatility and risk of loss corresponding to a specific portfolio strategy. Forty W Advisors recommends and/or manages different types of portfolio strategies. If you cannot tolerate the volatility and potential loss associated with a specific portfolio strategy, Forty W Advisors will introduce a different strategy to you for your consideration. Forty W's goal is to help you identify a strategy that best matches your investment objective and risk tolerance.

Note that these asset class assumptions are passive, and do not consider the impact of active management. Given the complex risk-reward trade- offs involved, we advise clients to rely on their own judgment as well as quantitative optimization approaches in setting strategic allocations to all the asset classes and strategies. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making an investment decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact future returns. Asset allocation/diversification does not guarantee investment returns and does not eliminate the risk of loss.