February 2026*
International equities outperformed in 2025, marking a potential inflection after a decade of US dominance. We expect this trend to extend into 2026, supported by a weaker US dollar, improving global cyclical momentum, and continued investment in AI-related capital expenditure. This quarter, we adjusted positioning to reflect a more pro-cyclical backdrop, upgrading Eurozone equities to overweight and downgrading Switzerland to neutral.
Last year was notable for international (non-US) equity outperformance and a potential shift in regional trends. The MSCI ACWI ex-US Index rose 32%, outperforming the US index by 15 percentage points. In addition, Chart 1 highlights that US outperformance – a persistent trend since 2011 – appeared to end in early 2025. These developments were consistent with a weaker US dollar and global investors diversifying toward more attractively valued non-US markets.
The natural question for investors is whether these trends will persist in 2026. Our baseline expectation is that international equities will continue to outperform, supported by USD weakness, an improving global cyclical environment, and corporate governance reform in selected markets (e.g., Japan and South Korea).
Previously, we argued that USD weakness was widely seen as consensus view yet remained an uncrowded and compelling trade (see our special report US Dollar Weakness: A Crowded Idea, Uncrowded Trade, July 2025). The depreciation trend appears to be re-establishing itself, with the US trade-weighted index (USTWBGD Index) down 1.5% year-to-date – a supportive development for non-US stocks.
Our original thesis focused on three core drivers: valuations, cyclical factors, and longer-term structural headwinds. Valuations remain stretched, with the real broad effective exchange rate (REER) around 12% above its long-term average. Cyclical drivers, such as rate differentials, remain broadly consistent with last year’s weakness and could drive further depreciation if the Fed continues to cut rates later this year. Our conviction on the Fed’s rate path is low over the coming months, particularly with a new incoming Fed Chair. Structural factors currently represent the primary downside risk for the greenback.
Our previous note highlighted that the dollar is likely to remain the world’s reserve currency for the foreseeable future, given the lack of credible alternatives (e.g., EUR and RMB). However, this does not preclude a gradual erosion of USD dominance and a more fragmented monetary system – with gold emerging as the clearest beneficiary to date. Treasury Secretary Scott Bessent’s recent reiteration of the “strong dollar policy” has done little to lift the currency, following President Trump’s comment that a falling dollar was “great”.
We have argued that efforts by the Trump administration to narrow the current account deficit should eventually result in weaker portfolio inflows and capital repatriation from countries with net international investment surpluses (see Chart 2). To date, the evidence does not point to a meaningful slowdown in US capital inflows. However, foreign investors can hedge FX exposure in anticipation of future developments, which likely explains the recent resumption of USD depreciation amid rising FX hedge ratios among global pension funds. Domestic challenges (e.g. Fed independence) and fraying external relations with both allies (e.g., the EU) and competitors (e.g., China) further encourage diversification away from USD assets.
| Chg | -2 | -1 | 0 | +1 | +2 | |
|---|---|---|---|---|---|---|
| US | – | |||||
| Canada | – | |||||
| Eurozone* | ↑ | |||||
| Switzerland | ↓ | |||||
| UK | – | |||||
| Japan | – | |||||
| Australia | – | |||||
| EM | – |
*Eurozone is overweight via the Netherlands, the other countries are neutral.
Note: Up/down arrows indicate a positive/negative change in our asset allocation compared to the previous quarter. A dash indicates no change.
Source: CLIM
| Chg | -2 | -1 | 0 | +1 | +2 | |
|---|---|---|---|---|---|---|
| Canada | – | |||||
| Eurozone* | ↑ | |||||
| Switzerland | ↓ | |||||
| UK | – | |||||
| Japan | – | |||||
| Australia | – | |||||
| EM | – |
*Eurozone is overweight via the Netherlands, the other countries are neutral.
Note: Up/down arrows indicate a positive/negative change in our asset allocation compared to the previous quarter. A dash indicates no change.
Source: CLIM
*This publication reflects asset performance up to 31 January 2026, and macro events and data releases up to 5 February 2026, unless indicated otherwise.
The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.