Monthly international market focus - February 2025

Market rotation goes global

A rotation in market leadership — across geographies as well as investment styles and sectors — has been a key theme this year. After a long stretch of underperformance, international equities made a comeback in the first two months of 2025, achieving their best two-month outperformance relative to U.S. equities in 35 years.*

As U.S. mega-cap tech stocks have turned from leaders to laggards, international indexes have benefited from tentative signs of improvement in the European outlook and enthusiasm about artificial intelligence (AI) in China. We’d offer the following perspective on what is driving the recent shifts and what they mean for investors.

Europe pivots to higher fiscal spending

Over the past two years, eurozone growth has stagnated, while the U.S. economy has managed to grow at an above-trend pace. Germany, which accounts for 30% of the region’s gross domestic product (GDP), has been particularly hurt by the slump in manufacturing.

However, following the German elections in February, the historically fiscally conservative country appears to be pivoting, proposing a massive stimulus program to boost defense and infrastructure spending. The plan includes:

• A €500 billion infrastructure fund that seeks to stimulate growth and modernize public facilities
• Higher defense spending , exceeding 1% of GDP exempt from debt restrictions
• The leeway of Germany’s regional states to run a small deficit

As of early March, these proposals still required a two-thirds majority in parliament. But if they’re passed, they will improve the growth outlook for the country and the region.

Additional sources of support for eurozone equities have been a potential cease-fire in the Russia-Ukraine conflict and improving economic data relative to depressed expectations.

AI enthusiasm moves east

DeepSeek’s AI breakthrough and the Chinese government’s shifting stance toward the private sector have acted as catalysts for a 16% year-to-date rally in the MSCI China index.*

DeepSeek is a lower-cost, competitive AI solution that uses fewer advanced chips relative to U.S. rivals. Its announcement has sparked optimism about an acceleration in AI demand and prompted discussions about the narrowing AI technology gap between the U.S. and China.

Internet and other growth stocks, which are well-represented in the China and emerging-market indexes, have seen stock prices and earnings rise strongly, while they continue to trade at reasonable valuations.

Diversification is key in 2025

Amid a leadership rotation, as well as policy and trade uncertainties, portfolio diversification will be critical, in our view, for investors to navigate this year’s twists and turns. The likely soft patch in the U.S. economy this quarter, together with improving international momentum, suggests the U.S. exceptionalism narrative may take a backseat for a while. Reflecting this dynamic, the U.S. dollar has dropped 5% against other major currencies since its January high.

We aren’t convinced the year-to-date rally in international stocks is the start of a new trend. However, the brightening outlook and wide valuation gap with U.S. equities argue that now is a good time for investors to review their international allocations.

A portfolio of 70% U.S. and 30% international equities five years ago would have drifted to a 78%/22% balance today. We recommend investors use pullbacks to add to international, cyclical and value-style investments if they are underrepresented in portfolios.

The shifting leadership is a positive development for diversified portfolios that stand to benefit from sector, style and geographic rotations.