why do international stocks underperform? A guide

This article answers why do international stocks underperform for dollar-based investors, summarizing historical cycles, drivers (currency, valuations, sector mix), empirical decompositions, and pr...

2025-11-20 16:00:00

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Why Do International Stocks Underperform?

A frequent question among investors is: why do international stocks underperform when measured in U.S. dollars? This article explains the scope—public equities listed outside the U.S., measured for dollar-based investors—and provides a practical, evidence-based review of historical patterns, the main economic and technical drivers, empirical decompositions, and actionable implementation choices. Readers will learn why relative performance depends on timeframe, index selection, and currency treatment, and how to think about diversification and allocation decisions without assuming permanent superiority for any single market.

As of 2026-01-16, according to institutional research from Morningstar and Vanguard, U.S. equities have led broad international indices since the 2008 Global Financial Crisis, with valuation expansion and sector leadership cited as major contributors to the gap.

Note: this article focuses on ex‑U.S. public equities for dollar‑based investors and uses widely followed benchmarks (for example, MSCI ACWI ex‑USA and MSCI EAFE) when discussing relative performance.

What this article answers

Why do international stocks underperform over some multi‑year stretches?
Which drivers (currency, valuation, earnings, sector mix, flows, policy, governance, index mechanics) tend to matter most?
What empirical evidence quantifies these contributions?
How should investors think about diversification, implementation, and common measurement pitfalls?

Historical patterns and performance cycles

Over long horizons, leadership between U.S. and international equity markets rotates. There is no permanent winner across every decade; instead, markets alternate dominance driven by macro cycles, technological revolutions, and valuation swings.

Historically, international markets have led in several decades and been lastingly behind in others. For example, the 1970s and parts of the 1980s saw strong non‑U.S. returns relative to the U.S., while the late 1990s technology surge benefited U.S. equities. The post‑2008 period is a clear multi‑decade instance of U.S. outperformance.

Short‑ and medium‑term outcomes are highly sensitive to start and end dates, index definition (developed vs emerging, ex‑U.S. vs world), and whether returns are measured in local currency or converted to dollars. Because of these sensitivities, broad statements that “international stocks always underperform” are misleading.

Representative episodes

U.S. dominance since the Global Financial Crisis (2008–mid‑2020s): A pronounced run where U.S. large caps—especially technology and growth firms—drove much of the gap.
Japan’s 1980s boom and multi‑decade stagnation: Japan led in the late 1980s, then experienced a prolonged period of underperformance through the 1990s and 2000s.
Early 2000s and cyclical leadership in parts of Europe and commodity exporters: Periods where international markets outpaced the U.S., often tied to commodity price cycles or local recoveries.

These episodes show that long runs of outperformance can reverse; past gaps are not destiny.

Main drivers of relative underperformance

Multiple interacting factors explain why, at times, international stocks underperform U.S. stocks for extended periods. The importance of each factor differs by era and region. Below are the principal drivers investors and researchers commonly cite.

Currency effects (exchange‑rate translation)

A primary short‑term amplifier of differences for dollar‑based investors is currency movement. When the U.S. dollar strengthens, the dollar‑returns of foreign‑currency‑denominated equities fall, even if local‑currency prices are unchanged.

Example mechanism: A European company whose shares rise 5% in euros will still show a negative dollar return if the euro declines more than 5% versus the dollar over the same period.
Magnitude: Currency swings can explain meaningful annual differences in some periods. Empirical work shows currency effects can trim or add several percentage points per year to dollar returns in volatile periods; over very long horizons currency often contributes less, but in the post‑2008 era a generally stronger dollar was a recurring headwind for unhedged U.S. investors in non‑U.S. equities.
Hedging: Currency‑hedged international funds remove exchange‑rate volatility but add cost and can underperform when the dollar weakens.

Valuation (multiple) expansion in the U.S.

A large share of recent U.S. outperformance is attributable to higher valuation multiples (for example, P/E, price‑to‑sales, CAPE) expanding for U.S. companies relative to peers abroad.

Why it matters: When price multiples rise faster in one market than another, that market's index can outperform even without faster earnings growth.
Evidence: Institutional decompositions frequently attribute the majority of the U.S–international performance gap since 2008 to valuation expansion. Depending on the study and period, multiple expansion explains roughly 50%–75% of the gap.
Drivers of multiple expansion include investor preference for growth exposures, perceived safety, and concentration of large, high‑growth companies in the U.S.

Earnings‑growth differentials and fundamentals

Beyond valuation effects, U.S. firms—particularly large technology, healthcare, and software companies—delivered stronger earnings growth in the 2010s and 2020s.

Growth companies that compound earnings faster naturally generate higher total returns, especially when valuations are already high but supported by robust revenue and profit expansion.
Part of the recent performance gap thus reflects genuine differences in corporate earnings outcomes, not only investor expectations priced via multiples.

Sector composition and market structure

Index sector weights matter. The U.S. index has been heavier in technology, communication services, and healthcare—higher‑growth sectors in recent cycles—while many non‑U.S. benchmarks have larger weights in banks, materials, energy, and industrials.

Consequence: Sector composition amplifies performance differentials when growth sectors outperform cyclicals.
Market concentration: U.S. large‑cap indices have become more concentrated around a handful of mega‑cap companies, which can drive outsized returns when those companies rally.

Capital flows, investor behavior and home bias

Net capital flows can reinforce valuation and performance gaps.

Passive and active flows into U.S. ETFs and funds have been substantial in the last decade, directing more capital into U.S. assets and supporting higher multiples.
Venture capital, initial public offerings, and private‑market depth in the U.S. concentrate growth potential domestically, feeding the public market pipeline.
Home bias: Many investors overweight domestic markets, reducing demand for foreign equities and perpetuating valuation gaps.

Corporate governance, accounting and investor protections

Differences in governance standards, minority shareholder protections, disclosure quality, and accounting rules affect perceived risk and therefore valuation multiples.

Markets with stronger governance and investor protections often trade at premium valuations; weaker protections add to the equity risk premium required by investors, lowering prices.
These structural differences can persist across decades and influence long‑run returns.

Macro policy, interest rates and safe‑haven dynamics

U.S. monetary and fiscal policy, relative GDP growth, and the dollar’s role as a global safe‑haven asset influence capital allocation.

When the U.S. delivers stronger relative growth or higher real interest rates, capital often flows into dollar assets.
In periods of global risk aversion, the dollar may strengthen, amplifying currency headwinds for non‑U.S. equities.

Index construction and measurement issues

How indices are built affects measured performance.

Market‑cap weighting concentrates returns in the largest companies; price weighting or equal weighting delivers different outcomes.
Treatment of American Depositary Receipts (ADRs), free‑float adjustments, sector mappings, and the choice of developed vs emerging benchmarks all change comparisons.
Measurement differences (price return vs total return, local‑currency vs dollar) can meaningfully alter conclusions about underperformance.

Empirical findings and quantified contributions

Institutional research commonly decomposes relative returns into: (1) valuation (multiple) changes, (2) earnings growth differentials, and (3) currency effects. While exact magnitudes depend on the period and indices, some consistent findings emerge:

Valuation expansion often explains the largest single share of the U.S advantage since 2008—many analyses estimate it accounts for roughly 50%–75% of the gap in that multi‑decade episode.
Earnings growth differences account for a meaningful share of the remainder; U.S. firms delivered stronger profit and revenue growth across many large sectors.
Currency effects have been significant in years when the dollar strengthened sharply; on an annual basis they can add or subtract several percentage points, but over very long horizons their contribution is typically smaller than valuation or earnings components.
Sector and concentration effects are important: analyses that re‑weight international indices to match U.S. sector exposures find a narrowed performance gap, indicating composition explains part of the differential.

Sources for these empirical approaches include institutional work from AQR, Vanguard, Morningstar, BlackRock, and academic papers that apply return decomposition methods.

Implications for investors

The fact that international equities have underperformed in recent decades should not be treated as proof of permanent inferiority. Instead, investors should weigh diversification benefits, valuation opportunities, and implementation choices against their goals and risk tolerance.

Diversification and risk reduction benefits

Adding ex‑U.S. equities reduces home‑country concentration risk and can lower portfolio volatility through imperfect correlation with U.S. stocks.
International allocations provide exposure to different sector mixes, dividend yields, corporate structures, and macro cycles.
Over long horizons, diversification can improve risk‑adjusted returns even if one region outperforms on average over a particular historical window.

Tactical vs strategic allocation choices

Strategic allocation: A long‑term policy allocation to international equities reflects a belief in the long‑run benefits of global diversification and a view on expected returns.
Tactical/actions: Investors who adopt tactical tilts might adjust weights based on relative valuation, momentum, or macro expectations, but timing is challenging and can increase transaction costs and turnover.
Rebalancing: Periodic rebalancing enforces discipline—selling relative winners and buying laggards—which can capture mean reversion if valuations revert.
Active management: In some markets, active strategies may find value opportunities due to less efficient pricing, but fees and implementation risk matter.

This is a general discussion and not investment advice.

Implementation considerations

Broad ex‑U.S. ETFs and mutual funds provide low‑cost access to diversified international exposure.
Regional slices (Europe, Japan, Asia Pacific, emerging markets) allow targeted exposures to valuation or thematic views.
Currency‑hedged vs unhedged: Hedged products reduce exchange‑rate volatility for dollar investors but come with hedging costs and may underperform when the dollar weakens.
Emerging markets vs developed: Emerging markets offer higher growth potential but greater volatility and governance risk.
Taxes, trading liquidity, and fees: Consider the tax treatment of dividends, liquidity of instruments, and total expense ratios when choosing vehicles.
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Common misconceptions and pitfalls

Confusing short‑term currency moves with structural underperformance: A strong dollar can make international returns look poor for U.S. investors even when local fundamentals are stable.
Assuming U.S. outperformance will persist indefinitely: Market leadership reverses across cycles; high valuations today imply greater susceptibility to mean reversion.
Ignoring index choice: Comparing the S&P 500 to MSCI EAFE mixes developed and emerging exposures incorrectly; use consistent and clearly defined benchmarks.
Overlooking dividends and total return: Price‑only comparisons can understate international returns where dividends are a larger share of total return.
Survivorship and data selection bias: Studies limited to surviving firms or short windows can misrepresent long‑run realities.

Measuring and interpreting “underperformance”

Measurement choices shape conclusions. Key methodological issues:

Local‑currency vs dollar returns: Dollar returns matter for dollar‑based investors; local‑currency returns isolate equity performance from currency moves.
Hedged vs unhedged returns: Hedged returns net out currency impacts; unhedged returns include them.
Benchmark selection: Ex‑U.S., developed ex‑U.S., and emerging indices differ materially.
Price return vs total return: Total return includes dividends and is the appropriate measure for long‑run wealth comparisons.
Time horizon choice: Rolling windows (for example, rolling 5‑ or 10‑year comparisons) reduce sensitivity to start‑date luck.
Survivorship bias and data coverage: Comprehensive datasets that include delisted firms and complete histories avoid upward biases.

When interpreting underperformance, be explicit about these choices.

Future outlook and open questions

Several uncertain factors could either reverse or extend recent trends:

Valuation mean reversion: High U.S. multiples may compress; if they do, international markets with cheaper multiples could outperform.
Dollar trajectory: A sustained weaker dollar would mechanically boost dollar returns for unhedged international investors.
Shifts in innovation leadership: Continued U.S. dominance in technology and services could sustain earnings growth differentials, while breakthroughs elsewhere could shift the balance.
Geopolitical and trade dynamics: Changes in trade patterns, regulatory regimes, or cross‑border investment rules can influence capital flows.
Changes in global monetary and fiscal policy coordination could alter relative risk‑free rates and risk premia across markets.

These are open questions; investors should evaluate scenarios rather than assume a single outcome.

References and further reading

Below are primary institutional sources and practitioner pieces useful for deeper, quantitative reading. Readers should consult the original reports for full methodology and data tables.

Morningstar — analyses of international vs U.S. performance and valuation trends (institutional commentaries and periodic research updates). Source: Morningstar reports (see latest publications as of 2025–2026).
AQR — academic and practitioner research decomposing returns into valuation and fundamentals; useful for methodologies on return attribution.
Vanguard — papers on diversification benefits and long‑term capital markets outlooks addressing international allocations.
BlackRock — investor education pieces on historical cycles and why international exposure matters.
J.P. Morgan Asset Management — guidance on expected returns and non‑U.S. allocation frameworks.
Fidelity — commentary on recent international performance and currency effects.
Practitioner blogs and research: Financial Samurai and Alpha Architect for tactical and implementation perspectives.

Sources: institutional reports and peer‑reviewed research published through 2025; for up‑to‑date data consult the underlying providers’ publications.

Appendix — Suggested charts and data to include in a full report

For a comprehensive article or report, include the following visualizations and data tables:

Rolling 5‑ and 10‑year relative returns: U.S. (S&P 500) vs MSCI ACWI ex‑USA and MSCI EAFE (dollar‑ and local‑currency).
Decomposition chart: contribution to relative returns from valuation change, earnings growth differential, and currency effect over rolling periods.
Sector weight comparison: S&P 500 vs MSCI EAFE vs MSCI Emerging Markets.
Currency index chart: trade‑weighted U.S. dollar index and correlation with international equity dollar returns.
Table of empirical study results: percentage contributions (valuation, earnings, currency) from representative institutional analyses.

Data sources: MSCI, S&P, Bloomberg, FactSet, Morningstar, national statistics agencies.

Further exploration

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