International Small-Caps Outpace U.S. Peers Amid Valuation Shift

International stocks have emerged as a potent alternative to U.S. equities, with recent data showing a clear performance lead over the past year. As U.S. markets navigate high valuations, tariffs, and geopolitical instability—including conflict in Iran—investors are increasingly diversifying into foreign markets. The performance gap is evident in major indices. The MSCI ACWI ex US Index posted a total return of approximately 40% over the last 12 months, compared to 36% for the Russell 3000. Since January 1, 2025, the international index has returned 35%, significantly outpacing the Russell 3000's 17% return. Small-cap international equities have been particularly strong. The Vanguard FTSE All-World ex-US Small Cap Index Fund (VSS) delivered a 30% total return in 2025, while its U.S. counterpart, the Vanguard Russell 2000 ETF (VTWO), returned 13%. Year-to-date through April 20, VSS has gained approximately 12%. Several macro factors are fueling this trend, including a weakening U.S. dollar and increased defense and infrastructure spending in key foreign markets. Furthermore, the AI boom is broadening beyond U.S. borders, allowing investors to find cheaper AI-related assets in emerging markets. Strategists at Vanguard suggest this outperformance could persist over the next decade. The combination of a massive valuation gap and the transformative impact of AI on international markets provides a compelling case for long-term diversification outside the United States.