The Diplomat author Mercy Kuo regularly engages subject-matter experts, policy practitioners, and strategic thinkers across the globe for their diverse insights into U.S. Asia policy. This conversation with Dr. Rory Knight – chairman of both Oxford Metrica and Jakota Capital AG, member of the John Templeton Foundation, and author of “International Investment Policy in the New World Order” (2025) – is the 460th in “The Trans-Pacific View Insight Series.”
Identify strategic trends in international investment policy in an increasingly deglobalized new world order.
As of May 1, 2025, the MSCI EAFE [Morgan Stanley Capital International Europe, Australasia, and Far East] index is up over 10 percent year-to-date whereas the S&P 500 has declined by close to 5 percent. This is a major reversal as U.S. equities have dominated the developed markets represented by the EAFE index for more than a decade. This reversal may be a harbinger of a longer-term trend. If so, there are profound implications for the asset allocation decisions of both U.S. and international financial institutions.
In the first decade of the millennium, international developed market (IDM) equities significantly outperformed U.S. equities. We argue that the year-to-date outperformance of U.S. equities by the IDMs may be a return to that form. U.S. financial institutions, particularly endowments and foundations, have under-allocated to equities outside the United States, and over the last 15 years, this strategy has paid off. Performance in the first quarter of this century has been a game of two halves. In the first half, international equities dominated U.S. equities. In the second half, however, the opposite has been true and the S&P 500 outperformed international equities by a significant margin.
We argue that the dominance of U.S. equities was in fact an aberration and investors need to seriously reconsider their international portfolio policies. Our analysis suggests that this under-weighting in IDMs needs to be reviewed. The factors driving the differential performance between the U.S. and the IDMs – principally monetary policy led by the Federal Reserve – have significantly changed.
In addition, the era of globalization with the attendant low interest rates has now come to an abrupt halt with the announcement of a return to trade tariffs.
What are the key benefits of international investing in the new world order?
There are five such benefits.
- Performance anomaly reversal: The factors favoring dominance of U.S. equities over the rest of the world have reversed. Globalization provided zero interest and a negative sloping yield curve, resulting in high valuations for U.S. equities combined with a strong dollar. Seven major U.S. technology stocks (the “magnificent seven”) accounted for all the differential between the U.S. markets and the rest of the world. That is now “priced-in,” and future returns are normalized.
- Natural diversification: The world economy has experienced an unprecedented period of macro-convergence through increased globalization and common monetary policies. The consequence has been an unusual degree of interdependence among the major economies, leading to an increase in correlation among equity returns. We now face a period of macro-divergence due to the shifts in geopolitics and the introduction of an era of trade frictions in the global economy.
- Reduction in portfolio concentration: The top ten stocks in the MSCI U.S. constitute 36 percent by weight compared to 13 percent in the rest of the world. An allocation away from the U.S. naturally reduces concentration risk and adds a multiplier effect to the benefits of natural diversification.
- A wider alpha opportunity set: There is a further impetus to invest in IDMs to search for international alpha. The likelihood of identifying such opportunities is considerably expanded in the larger pool of stocks outside of the domestic market.
- Current undervaluation in IDMs: There is much evidence that the dominance of U.S. equity markets has led to a cumulative undervaluation of international assets which now appear attractive to investors.
Examine how key geopolitical risk vectors, such as China-U.S. competition, are shaping investor confidence and outlook.
There are three key geopolitical risk vectors: geopolitical, inflation, and regulation (tariffs). Political risk has not been a major factor in equity pricing for the last few decades; it is now. After an initial setback in early 2020, the market recovered from COVID-19 and was above the pre-pandemic high in a year. The start of the Russia-Ukraine war in February 2022 saw a downturn in equities, and by the end of 2024, these losses had been recovered. The new administration in the U.S. is taking positive if unorthodox steps to stop the war. This is a positive force for markets. Paradoxically, markets are reacting negatively, but many factors are at play. The world should emerge from the war soon and there will be a positive stimulus as the rebuild commences.
However, the world is now a very different place. Despite the anticipated cessation in hostilities, inflation is again a significant risk. Central bank balance sheets are bloated with limited capacity to exercise further quantitative easing.
U.S.-China trade tensions together with the Ukraine war have caused much fragmentation and deglobalization. The combined effect will weigh heavily on world growth, which is highly inflationary for monetary reasons.
The single strongest change vector is regulation in the form of government-imposed tariffs. It is difficult to predict the effects this will have as a new game-theoretic equilibrium emerges in a deglobalized world. We predict macro-divergence, increased inflation, and a weaker dollar, all translating into greater equity market volatility. However, we believe that markets will look beyond the transitory impact of the structural changes being imposed by the new U.S. administration.
What implications does the new world order have for investment policy?
2025 heralds a potential change in the dynamic of the world economy, which has repositioned IDMs relative to domestic markets. Inflation with the attendant high interest rates and sluggish growth in the U.S. with a weaker dollar will place IDMs in a more competitive position vis-à-vis domestic markets in the coming years. The Templetonian paradox of trouble is opportunity applies. The macro fundamentals in IDMs are relatively strong; the equity market technical measures currently imply pessimistic valuations in these countries, which in short presents an opportunity for the long-term investor. Allocations to IDMs are at an all-time low, which is a consequence of both the relative under-pricing of the asset class and a conscious risk aversion on the part of institutional investors. Political strains with the U.S. and the rest of the world certainly do not help allay these fears.
Assess the implications of your analysis for investors.
The analysis we present seeks to provoke investors to consider increasing their allocations to IDMs from the current average levels of around 6 percent to around 15 percent, which is higher than the 20-year average level of 10 percent. The main motivation for this policy is two-pronged: the diversification benefits to hedge the risks of the domestic markets and to seize the return opportunities of specific equities in IDMs.
We propose a highly focused approach that seeks out individual stocks in these markets, taking into consideration their growth opportunities and natural protection from inflation and currency risks. These markets are bristling with such opportunities. We recommend against a passive allocation as all markets continue to carry much risk. The trade tariffs in particular represent a serious challenge to investors and seeking a wider spread of risk is imperative to at the very least preserve capital.