You don't need divine intervention to reduce US equity holdings

Published in The Sunday Times on 14th September 2025.

The serenity prayer asks the divine to grant the poise to accept the things we cannot change, the courage to change the things we can, and the wisdom to know the difference. 

It feels like investors today may be on bended knee with a skyward gaze as they cast an eye over their portfolio allocation to US assets.

It’s difficult to be serene with a benchmark weight in US equities

The US stock market represents more than 70% of developed global equity benchmarks – a fact we cannot change. US markets are trading near all-time highs and depending upon the valuation metric you choose to use, are trading at very stretched multiples, implying lower than average future returns.

It’s difficult to be serene as an investor with a benchmark weight in US equities.

But there are things we can change. I think there’s a strong case to be made for investors increasing allocations to non-US equities. 

The S&P 500 has outpaced the rest of developed market equities by a cumulative 150% in the past fifteen years. So being underweight the US has hurt. Fascinating analysis done by US investment manager GMO questions whether the factors that drove the exceptionalism of the US in the last fifteen years can be relied upon going forward. In short, the answer is no. 

It’s worth mentioning that this same manager has been persistently bearish on the US throughout this period. But its analysis bears scrutiny.

What drives stock market returns?

First, it’s important to understand what drives stock market returns. Two things drive markets over time:

• Earnings, including dividends.
• And the increase or decrease in how much investors are willing to pay for those earnings (i.e. what valuation multiple).

That’s it. It isn’t any more complicated than this. Every movement – short or long term – is a function of one of those two things. 

So we have two variables. One is predictable and compounds, the other is unpredictable but doesn’t compound. 

Populations grow and workers generally get more productive over time. Hence, earnings tend to grow and compound in a way that makes their growth reasonably predictable at an aggregate level i.e. earnings are more predictable at the market level rather than at individual company level.

Changes in valuations are highly unpredictable because they mostly reflect shifts in public sentiment. And they don’t compound over time. There may be a reasonable argument to be made for increasing valuation multiples as interest rates decrease and vice versa, but there are limits to this effect.

GMO’s analysis of returns

So let’s return to GMO’s analysis and see what has driven US stock market returns in the last fifteen years.

U.S. stocks did deliver on fundamental returns. Dividends, share repurchases, and organic growth – outperformed the rest of developed markets. 

But according to GMO, approximately 80% of US outperformance came from a combination of relative valuations expanding and the dollar strengthening against almost every currency in the world.

With US equity valuations already high, reliance on the continued expansion in multiples seems like a fool’s errand. And as for the the dollar, it too is expensive, and the U.S. administration is pushing for trade and monetary policies that will likely weaken the currency. 

To its credit, the US stock market is home to some of the most incredible companies, which have grown their earnings at an astonishing rate. The historical average growth rate for equity fundamentals (earnings and profits) globally has been approximately 6% in real terms. Over the five years ending 2024 the Magnificent Six (excluding Tesla as it was not in the S&P500 for the entire period) delivered almost 3 times the global average growth in equity fundamentals. 

International stocks have delivered better earnings than their US counterparts

The magnificence of six of the very largest companies in the U.S. stock market has led to an assumption that U.S. companies on average have done well. The data don’t bear this out. The median fundamental return for a stock in the S&P 500 (ex-financials) over the five years ending 2024 was 4.0% pa. Meanwhile, the median fundamental return of their international counterparts was a very healthy 6.1%.

International stocks are cheap

In addition to competitive growth rates, the added – if not main - attraction of international stocks is their valuations. The UK, Europe, Japan, and the rest of developed markets all trade at a 33% to 55% discount to US equities.

Stock markets outside the US are cheap – sometimes they can be cheap for a reason. But leaning against the US trend seems like a reasonable bet to me at this point. 

The so-called “widow-maker” trade over the last generation was shorting Japanese government bonds. Yields stayed lower for a lot longer than many investors thought possible, despite Japan’s massive debt, poor demographics and ultra loose monetary policy. 

US exceptionalism could continue for a lot longer than I think is possible – so a move out of the US requires courage. And if you believe in the almighty, a prayer wouldn’t go amiss either.
 

Source: Data is sourced from Bloomberg as at market close 31st December, returns are based on total indices in local currency terms, unless otherwise stated.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on X at @gconno1.