Notes on the Week Ahead – Episode Summary

Podcast: Notes on the Week Ahead
Host: Dr. David Kelly
Episode: International Equities: Looking Beneath the Currency Icing
Date: January 20, 2026

Overview

In this episode, Dr. David Kelly explores the strong performance of international equities relative to US stocks in 2025 and the outlook for 2026. He uses the metaphor of a fruitcake—delicious but underappreciated by Americans—to illustrate the case for international investing, particularly when looking past the "currency icing" to the core fundamentals. Dr. Kelly analyzes macroeconomic prospects, monetary and fiscal policies, earnings expectations, and valuations across major international regions (Eurozone, UK, China, and Japan). He argues that international equities offer defensive qualities, attractive valuations, and the potential for strong future returns, especially with the expectation of a falling dollar.

Key Discussion Points and Insights

1. Fruitcake Metaphor & American Skepticism

• Dr. Kelly’s opening analogy: Americans don’t like fruitcake, just as they often avoid international stocks despite their recent outperformance.
  • ["Americans also generally don't like international stocks. Nevertheless, last year international stocks trounced their US counterparts...." (01:20)]

2. International Outperformance in 2025

• 2025 returns:

  • MSCI ACWI ex-US: 33% total return (USD)
  • S&P 500: 18% total return
  • Currency impact: Currency contributed 8 percentage points to non-US returns, but even in local currencies, gains were strong (25%).

• Conclusion: Currency is just the "icing"; core international returns were strong on their own.

  • Quote:

    "But currency was just the icing on top. Even in local currency terms, the Acwex US gained 25%."
    — Dr. David Kelly, (01:45)

3. 2026 Outlook: Why International Still Matters

• Falling dollar: Expected to continue boosting international returns.
• Fundamentals: It’s critical to look beyond currency effects at underlying fundamentals:
  • Economic growth
  • Fiscal and monetary policy
  • Earnings prospects
  • Valuations

4. Regional Economic Analyses

Eurozone

• 2025-2026 growth: Moderate and balanced (~1.5% GDP growth).
• Unemployment: 6.3% (near historic lows).
• Inflation: 1.9% (very close to ECB’s 2% target), ECB deposit rate at 2% and likely staying there.

UK

• Softening economy: Unemployment up to 5.1% (from 4.3%), growth slowing to 1.4% in 2025, expected to slow further in 2026.
• Inflation: 3.2% but expected to drop to 2% by summer 2026.
• Monetary policy: BOE cut rates slightly, further cuts expected.
  • "Futures markets are pricing in two further 25 basis point cuts for 2026." (05:10)

China

• GDP growth: 5.0% in 2025 (in line with government targets).
• Exports: Up 5.5%, with reduced reliance on US market (10% of exports, down from 20% in 2017).
• Concerns: Falling birth rate, property worries, and negative inflation indicators.
• Fiscal stimulus: Large deficits expected, raising debt sustainability concerns.
  • "China will likely try again to stimulate demand by holding the central government fiscal deficit at 4% of GDP." (08:15)

Japan

• Momentum: 2025 GDP growth above 1%, expected to continue with new stimulus under PM Sanae Takeshi (pending February 8 elections).
• Inflation: Now a significant issue after years of stagnation (3% average since 2022).
• Policy responses: Proposed temporary tax suspensions on food and fuel, but Bank of Japan now tightening rates.
  • "The Bank of Japan, having raised the overnight rate to 0.75% in December, is expected to raise overnight rates at least once more and perhaps twice in 2026." (11:15)

5. Corporate Earnings and Valuations

• Earnings Outlook:
  • 2026 EPS growth estimates: US (15.5%), Europe ex-UK (12.8%), UK (10.6%), Japan (11.4%), China (12.6%)
  • Dr. Kelly believes these may be too optimistic.
    • "All of these numbers look too optimistic given the macro backdrop, but the convergence is notable." (14:10)
• Valuations:
  • S&P 500 trading at a high 22.2x forward P/E
  • Overseas markets: Lower teens (FTSE 100: 13.6x, Topix: 16.7x)
  • International stocks offer much higher dividend yields (Japan: 2.2% – UK: 3.3% vs. US: 1.2%)
    • "Even after a great performance year for international stocks, they remain significantly cheaper than their US counterparts." (15:05)

6. Currency Effects ("Icing on the Cake")

• Coordinated fiscal stimulus: Eurozone, China, Japan, and US all engaged.
• Interest rate divergence: Fed likely to cut rates more than other central banks, pushing the USD down further—amplifying returns on non-US assets.

7. Portfolio Implications & Final Metaphor

• International stocks (like the fruitcake Dr. Kelly uses as marathon fuel) are both a growth opportunity and a defensive asset.

  • "International equities are significantly cheaper and higher yielding than their US counterparts and should help portfolios weather a general downturn in global markets." (18:10)

• Resolution for US investors: Diversify internationally for both upside and protection.

  • Quote:

    "If it's not too late for New Year's resolutions… US investors should resolve to apply international diversification to their very US-centric equity portfolios."
    — Dr. David Kelly, (19:15)

Notable Quotes & Memorable Moments

• On the currency being only the icing:

  "But currency was just the icing on top. Even in local currency terms, the Acwex US gained 25%."
  — Dr. David Kelly (01:45)

• On international valuations:

  "Even after a great performance year for international stocks, they remain significantly cheaper than their US counterparts."
  — Dr. David Kelly (15:05)

• On why to diversify globally:

  "International equities are significantly cheaper and higher yielding than their US counterparts and should help portfolios weather a general downturn in global markets."
  — Dr. David Kelly (18:10)

• On New Year's resolutions for US investors:

  "US investors should resolve to apply international diversification to their very US-centric equity portfolios."
  — Dr. David Kelly (19:15)

Key Timestamps

• 00:04: Fruitcake metaphor & parallels with international equities
• 01:20: 2025 performance—international stocks vs. US
• 03:10: Economic & policy overview (Eurozone, UK, China, Japan)
• 05:10: UK’s economic slowdown and rate cuts
• 08:15: China’s shifting trade patterns & fiscal policy
• 11:15: Japan’s growth, inflation, and policy changes
• 14:10: Earnings and valuation analysis
• 15:05: International dividend and P/E comparisons
• 18:10: Defensive role of international stocks
• 19:15: Diversification as a New Year’s resolution

Conclusion

Dr. Kelly encourages investors to “look beneath the currency icing” and recognize the inherent value and diversification benefits of international equities. Despite US investors’ historical reluctance, the fundamentals, policy backdrop, and especially valuations, support increasing international exposure. Whether 2026 brings robust growth or unexpected downturns, international stocks—like a fruitcake after the holidays—are both nutritious and underappreciated, deserving a key place in global portfolios.