2025 International Equities Outperformance: Drivers and Secular Trends

This analysis synthesizes data from multiple sources to explain the 2025 outperformance of international equities. Performance metrics show the MSCI All-World ex U.S. Index has risen 17% year-to-date, exceeding the S&P 500’s ~14.76% gain [0][1]. Two primary macroeconomic factors drive this divergence: U.S. policy uncertainty (including tariff dynamics and Federal Reserve rate cut ambiguity) that has dampened U.S. growth expectations [2], and significant fiscal expansion in Europe and Japan. Japan implemented record stimulus packages [3], while Germany increased debt sales to fund spending [4]. Both regions also saw substantial defense spending growth—Europe targets an 80% increase by 2030, and Japan aims to double defense spending to 2% of GDP by 2027 [5]. Additionally, AI innovation is emerging as a key growth driver: Japanese startups are applying AI in manufacturing and business SaaS [5], while European startups experience rapid growth amid regulatory adjustments to foster AI development [6].

The international equities rally reveals a shift in global growth dynamics, with non-U.S. markets capitalizing on structural trends:

1. Fiscal policy divergence: Expansive spending in Europe and Japan contrasts with U.S. policy uncertainty, attracting capital to regions with more predictable growth trajectories.
2. AI innovation is geographically diversified: Non-U.S. markets are not just adopting AI but developing region-specific applications, particularly in manufacturing (Japan) and startups (Europe).
3. Defense spending serves as a dual catalyst: It directly boosts defense sector revenues and indirectly supports industrial reshoring efforts by enhancing regional supply chain security.

• Non-U.S. AI and manufacturing sectors present emerging growth opportunities due to policy support and innovation.
• Defense spending expansions in Europe and Japan create long-term demand for defense contractors and related industries.
  
  Risks
  :
• Sustained U.S. policy uncertainty could disrupt global capital flows, affecting international markets indirectly.
• Geopolitical tensions may escalate despite defense spending increases, introducing volatility.
• Regulatory adjustments in Europe could create uncertainty for AI startups if rules are more restrictive than expected.

International equities outperformed U.S. markets in 2025 due to U.S. policy uncertainty and increased fiscal spending in Europe and Japan, supported by secular trends including defense spending growth, AI innovation, and reshoring. The MSCI All-World ex U.S. Index rose 17% YTD, compared to the S&P 500’s ~14.76% gain. European and Japanese markets are leveraging defense spending and AI innovation to drive growth, with Japanese startups focusing on manufacturing AI applications and European startups benefiting from regulatory adjustments. While these trends present opportunities, investors should be aware of potential risks from continued U.S. policy uncertainty, geopolitical tensions, and regulatory changes.