U.S. stocks had a fantastic 2025. The S&P 500 (^GSPC 1.52%) finished the year up 16.4%, despite a sharp drop in March and April.
But investors in international stocks did even better. The MSCI World ex USA index, which tracks large- and mid-cap stocks from developed markets outside the U.S., climbed 32.6% for the year. That was fueled by a weakening dollar and rotation away from the U.S. due to President Donald Trump's trade policies.
U.S. equities have handily outperformed international stocks over the last two decades, but adding international exposure has historically been seen as a good form of diversification for American investors. These equities handily outperformed the S&P 500 in the mid-2000s and several other periods throughout history.
With that in mind, investors should be asking whether international stocks can build on their momentum from last year and continue to outperform in 2026 and beyond. The economist Robert Shiller, a Nobel Prize winner, weighed in on the markets last quarter.
Image source: Getty Images.
Is the U.S. market poised for a slowdown?
Despite international stocks outperforming it, the S&P 500 still had a very impressive year. Even more impressive, however, is the fact that it produced total returns of 26.3% and 25% in the two years prior. Since 2009, the S&P 500 has produced total returns at an average annual rate of 14.8%. That's well above the index's historic average.
The prices of stocks in the S&P 500 have climbed more than twice as fast as their cumulative earnings-per-share growth since 2009. As a result, the aggregate forward price-to-earnings ratio (P/E) for the index has climbed to a level rarely seen since the dot-com bubble. Large-cap U.S. stocks currently trade for nearly 22 times forward earnings expectations.
Robert Shiller prefers to use long-term inflation-adjusted earnings history to value the overall market. The metric he developed, the cyclically adjusted price-earnings (CAPE) ratio, is often referred to as the Shiller PE. It can smooth out economic cycles and provide a better long-term outlook for stock returns based on valuation.
Today, the CAPE ratio has climbed above 40. The only other time it reached this level was at the height of the dot-com bubble.
As a result, Shiller sees very muted returns for the S&P over the next 10 years. His most recent forecast calls for average annual nominal returns of just 1.5% over the next decade. At that rate, investors are unlikely to keep up with inflation.
Shiller sees the high valuations of U.S. stocks as a major headwind to continued gains. Even with strong earnings growth, he says, stocks will likely face multiple compressions over the next decade, weighing on their ability to increase in value.
That doesn't mean investors won't see gains. Shiller's 95% confidence interval includes the potential for average returns over the next decade of about 10.7%, around the S&P's historic average. But he also sees potential downside as well, with the bottom end of that range at a negative 7.7%.
Values look more appealing in other markets
While U.S. stocks have climbed to historically high valuations, earnings multiples in Europe and Japan have remained relatively calm over the last decade and a half. Even after international stocks' strong performance in 2025, they still look relatively cheap compared to U.S. equities.
NASDAQ: VXUS
Key Data Points
But there are some good reasons European and Japanese stocks may trade at lower valuations. For one, neither region has nearly as much exposure to the biggest growth trend of the last decade: artificial intelligence (AI). Only a handful of the most popular AI-related stocks are traded in international markets.
Moreover, they aren't as corporate-friendly. The U.S. has tons of investment capital and currently offers extremely low tax rates. That capital isn't as available in Europe or Japan, and corporate tax rates in Japan and Germany are considerably higher than average among all nations.
Nonetheless, international stocks look more appealing since they trade closer to their historic average CAPE ratios. As a result, Shiller expects European stocks to produce an average annual return of 8.2% over the next decade, and Japanese stocks could return 6.5% per year based on his forecast. It's worth noting that while Japanese stocks trade below their 20-year average CAPE, the bubble its stock market experienced in the 1980s may distort the forecast.
So, Shiller thinks international stocks can continue outperforming in 2026 and beyond. Investors looking to capitalize on that trend could consider adding exposure to international index funds like the Vanguard Total International Stock ETF (VXUS 1.99%), the iShares Core MSCI Europe ETF (IEUR 1.46%), or the Franklin FTSE Japan Hedged ETF (FLJH 1.50%). All three offer great options with low expense ratios that can provide some international diversification to your portfolio.
