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The performance of international equity markets in the first couple of months of 2026 has continued the pattern of 2025, with international and emerging markets substantially outperforming the U.S.
The underperformance of the U.S. for international investors was exacerbated by the weakness of the U.S. dollar, which was down 10% on a trade-weighted basis last year, although it has been flat so far in 2026.
While the S&P 500 Composite is flat and the Nasdaq Composite is off 2%, the iShares Mexico ETF (NYSE: EWW) is up 18%, the iShares Japan ETF (NYSE: EWJ) is +16.5%, the iShares Emerging Markets ETF (NYSE: EWM) has gained 11.7%, the iShares United Kingdom ETF (NYSE; EWU) is up 7.4%, and the iShares Europe 350 ETF (NYSE: IEV) is ahead 6%.
To some extent, this reflects the continued uncertainty caused by the Trump administration's rapidly shifting tariff policies and their effect on the domestic economy, where the increased costs due to tariffs are contributing to the cost-of-living crisis. It’s also reflecting the decision by international investors to diversify away from the very concentrated U.S. equity market, where the largest companies, the so-called Magnificent Seven of large cap technology companies (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) account for almost 40% of market capitalization.
With estimates of over US$600 billion in capital expenditure this year by the Magnificent Seven on building out Artificial Intelligence (AI) networks and data centres, there are increasing worries about whether much of this spending will ever be profitable. Investors are realizing there will be winners and losers in the AI race.
Companies have taken advantage of falling interest rates, with short-term U.S. interest rates down to 4% from 5.5% over the last 18 months and declines of 1.0-1.5 percentage points in Europe and the UK.
However, the enormous capital spending on the AI buildout by the U.S. technology giants has seen them moving from running large cash balances to taking on heavy borrowings, even though the coupons on their bond issues are relatively low.
The cost of servicing these large debts will reduce the profitability of the technology companies. This will put further pressure on their extended valuations, with Nvidia selling at 48 times 2025 earnings, Apple 33 times, and Alphabet 29 times. While Microsoft and Amazon are selling for a more reasonable 26 and 27 times, this is due to their sharp price declines in the last month. Microsoft is down 17% and Amazon is off 14% as investors worry about the size of their commitments. Incidentally, Microsoft is up 66% and Amazon 22% over the last five years, compared with 75% for the broader S&P 500 as well as the MSCI World Index and S&P/TSX 60.
The low weighting in technology and communications, which has been the principal reason for the underperformance of non-US markets, both developed (such as Europe and Japan) and emerging markets, is now perceived as less of a disadvantage.
There is now recognition that the AI buildout as well as the continued electrification of automobile markets requires massive amounts of hard assets such as commodities like copper, nickel, cobalt, steel, and lithium, as well as rare earths. Then there is the energy required to power the process, including uranium for nuclear, conventional oil and gas, as well as metals needed for solar and wind production.
Markets with a high exposure to metals and materials, such as Canada, Australia, Brazil, Mexico, Chile, and South Africa, have all been beneficiaries of this trend, but so-called “old economy” industries such as autos, aerospace, defense, and industrials, which includes many European economies and Japan, are also seen as attractive areas to invest in.
In this type of investment environment, it makes sense to add to diversified portfolios an additional selection in a sector that is set to benefit from a secular change in governments' attitudes, namely defence.
The Russian invasion of Ukraine four years ago (and more recently the US/Israel war with Iran) and the realization that the Trump administration is no longer willing to provide a security umbrella for Europe has led to a massive increase in defence expenditures to reach NATO’s target of 5% of GDP by countries such as Germany that were formerly reluctant to do so.
Investors looking for defense industry exposure might look at a long-established European defense giant that is the largest U.K. defense contractor and a major supplier to the U.S. armed forces.
BAE Systems plc ADR (LSE: BAE; OTC: BAESY) was formed from a merger between the former British Aircraft Corporation, several shipbuilders, and Royal Ordnance, the British army's munitions business which dates back to the sixteenth century. BAE manufactures aircraft, ships, armoured vehicles, missiles, electronics, and cyber security systems. It employs 110,000 people in over 40 countries, and with a market cap of US$81 billion is the largest European defense business.
Like virtually all major defense stocks, BAE has been a strong performer, up 71% in the last year.
BAE has extensive and long-running programs in virtually all fields, in both Europe and the U.S., as well as increasingly in Asia and Australasia. Given the national security aspects of defense expenditures, suppliers such as BAE have very longstanding relationships with the governments they deal with, which are reluctant to replace reliable providers.
Half-year results to June 30, 2025, saw BAE Systems revenues rise 11%, to £14.6 billion, while underlying earnings before interest and tax (EBIT) rose 13%, to £1.55 billion and earnings per share (EPS) climbed 12%, to £0.347. The order intake was £13.2 billion, down £1.9 billion from the previous half year, which reflects the lumpy nature of BAE's business, with major order programs occurring on an irregular basis. Its order backlog stood at £75.4 billion.
BAE pays two semi-annual dividends, split 60/40 between final and interim. The final dividend for 2024 was increased 11%, to £0.205 per share, while the interim for 2025 was £0.135 per share, making a total of £0.34, equivalent to a dividend yield of 1.2%. For Canadian investors, it is treated as a foreign dividend and subject to 15% withholding tax.
BAE Systems is for investors looking for exposure to the defense industry with a long-established contractor, supplying multiple weapons platforms with capabilities in many different fields. It is selling at a reasonable valuation even after its recent increase in price. As always, do your homework before investing and consult your financial advisor to ensure the stock fits with your financial objectives and risk-tolerance level.
Gavin Graham is a veteran financial analyst, money manager, formerly Chief Investment Officer of BMO Financial, and a specialist in international investing, with over 35 years’ experience in global investment management. He is currently Chief Investment Officer of Calgary-based Spire Wealth Management.
Notes and Disclaimer
Content copyright © 2026 by Gavin Graham. This is an edited version of an article that first appeared in The Income Investor newsletter. Used with permission.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
Image: iStock.com/bondgrunge
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