Great news: Your S&P 500 fund is underperforming. I mean, it's still doing great and all. You've made close to 10% there so far this year, which is historically the average return for a full year, and it's only July. But your other stuff is doing better. Well, not bonds. They've stunk. Your iShares Core U.S. Aggregate Bond exchange-traded fund is flat. I meant your other stock stuff.
Remember that ETF you tucked away that invests in developed markets outside the U.S. -- the one that looked cheap but has lagged behind the S&P 500 forever because it's loaded with crusty old companies in Europe and Japan? Well, the Schwab International Equity ETF has made over 14% this year.
And that emerging markets ETF that was taking forever to bounce back because China has turned into portfolio poison? China doesn't look much better. But South Korea is killing it. Taiwan, too. Your iShares MSCI Emerging Markets ETF has made a spicy 21% year-to-date.
By the way, both of these overseas funds, developed and emerging, beat the S&P 500 by a lot in 2025, too, but that was partly because the value of the dollar tanked last year as the Federal Reserve was cutting interest rates. Now rate cuts are on pause, and the dollar has rebounded this year. That should be a drag on overseas funds, which makes their continued outperformance even more striking.
U.S. small-caps were lousy last year -- and the past decade. This year? Your Vanguard Small-Cap ETF has made 15%. No, this isn't a dream, you dutiful diversifier. Your day has come.
All of this raises two questions. What's going on? And how long will it last? In short, the search for artificial-intelligence winners is broadening, but that's not the whole story. In Europe, for example, overall market fundamentals are looking genuinely better, and shares remain reasonably priced. Other regions and asset classes are closer calls.
Last month, I briefly mentioned here that one investment bank had laid out a case for crushed rocks as an AI investment. All that data-center construction requires plenty of aggregate for making concrete, as it happens. This past week, an investment advisor tipped me off on the AI excitement around fertilizer. Apparently, neural networks are the key to chemical companies making more of the stuff, and farmers with their smart spraying technology are using less of the stuff, which sounds to me like it offsets, but never mind that. When the AI storyline in U.S. large-caps has reached rocks and fertilizer, maybe we're digging too hard.
There is fertile ground for AI buzz overseas, too. Investors long ago figured this out in the case of South Korea, a dominant memory manufacturer, and Taiwan, which leads the world in contract manufacturing for sophisticated chips. Notwithstanding a recent selloff in South Korea, both markets have turned in stupendous returns since last year, fueled by a handful of giants, especially SK Hynix and Samsung Electronics for South Korea, along with Taiwan Semiconductor.
UBS argues in a new report that emerging markets are likely to continue outperforming during the second half of this year, as South Korea and Taiwan continue thriving, and Brazil, South Africa, and even China make positive contributions. Maybe UBS is right, but about $3 of every $10 invested in that emerging markets ETF is tied to the three aforementioned memory/chip giants. So if you're turning to emerging markets for diversification away from AI mania in the U.S., you're not getting as much as you might want. Then again, that overall emerging markets ETF is priced at only 12 times earnings.
The case for developed markets ex-U.S. is less AI-centric. True, the top performer this year in that ETF is a Japanese memory maker called Kioxia Holdings. It was once part of Toshiba, until that company a decade ago got into financial trouble buying a nuclear construction company called Westinghouse, and had to sell a controlling stake in its prized memory business to Bain Capital. Also, to confuse matters, South Korea is included in the developed markets ETF, even though it's also in the emerging markets one, so Samsung Electronics and SK Hynix have played a role, along with ASML Holding, a Dutch maker of advanced chipmaking machines. But at least in the developed markets index, these three leaders combine for less than $1 of each $10 invested.
Better news from other European sectors has also helped. Bank earnings estimates are pushing higher. A weaker euro has made defensive companies less of a drag. "Positive conversations are no longer confined to semis and AI beneficiaries," wrote UBS recently. "Luxury, staples, pharma, banks, and industrials are all reporting a more stable or improving earnings outlook, making downside increasingly difficult to find at the index level."
If I'm quibbling, downside isn't "difficult" to find in any stock index investment. It will present itself quite easily if and when it cares to, with little warning. But the point, I think, is that Europe's earnings growth rate has pushed north of 10%, giving it a price/earnings ratio of 15 and making UBS's case that it should rise to 16 look undemanding, especially compared with the S&P 500 at 22 times earnings.
U.S. small-caps have benefited from better earnings growth and lingering help from last year's rate cuts, since many small companies use short-term, variable-rate financing. Also, some smaller industrial companies make doodads that are in strong demand for the data-center buildout. And small-caps were cheap. But at a recent 20 times earnings, they're looking less so. BofA Securities recently wrote that it prefers mid-caps in general for the rest of this year, although it also highlighted its top small-cap stock picks. The list includes Toll Brothers, e.l.f. Beauty, Life Time Group, Charles River Laboratories International, and Knight-Swift Transportation.
Write to Jack Hough at jack.hough@barrons.com and subscribe to his Barron's Streetwise podcast.
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(END) Dow Jones Newswires
July 10, 2026 21:31 ET (01:31 GMT)
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