Overseas Rally Crumbles as Iran Conflict Drives Cash Back to U.S. Shares

Iran War Erases 10% From ex-US Benchmark in Three Weeks

• MSCI’s non-U.S. gauge has fallen roughly 10% since fighting began in late February.
• U.S. equities are off only 5.4%, reversing a January rotation into overseas markets.
• Germany’s DAX has slid 11% and Tokyo’s Nikkei is down 9.3%.
• Analysts see the safe-haven bid for the dollar prolonging American outperformance.

Geopolitical shock stalls the long-awaited foreign-stock comeback.

IRAN WAR—Investors entered 2026 betting that cheaper valuations and a weaker dollar would crown international shares the new leaders. Instead, a military flare-up in Iran has vaporised that narrative almost overnight. Since the first missiles flew on 23 February, global bourses outside the United States have surrendered about 10% of their value, while domestic benchmarks have absorbed a milder 5.4% hit, according to MSCI data through 21 March.

The violent reversal highlights how quickly geopolitical risk can overwhelm fundamental story lines. Flow-tracker EPFR Global says more than $18 billion has been pulled from ex-US equity funds in the past three weeks, the fastest redemption pace since Russia invaded Ukraine. Meanwhile, the dollar index has jumped 2.7%, underscoring the reflexive bid for U.S. assets when crude-supply anxiety spikes.

For fund managers who had trimmed American exposure in January, the timing is painful. “War has forced a rethink of the whole rotation trade,” says Lori Calcaterra, head of asset allocation at Hightower Advisors. “Energy security and reserve-currency status suddenly matter more than price-to-book ratios.”

Rotation Trade Unravels in Real Time

Until mid-February, the narrative was textbook: U.S. valuations looked stretched after a decade of mega-cap dominance, the Federal Reserve was hinting at rate cuts, and a softer dollar promised to flatter foreign earnings translated back into greenbacks. Portfolio managers responded by pouring a net $42 billion into international equity funds during the first six weeks of the year, the strongest start since 2012, EPFR data show.

The Iran conflict vaporised that momentum. From Frankfurt to Tokyo, indexes most reliant on imported energy have absorbed the sharpest blows. Germany’s DAX, where chemicals giant BASF and carmakers face spiking gas prices, has fallen 11% since 23 February, nearly double the S&P 500’s decline. Tokyo’s Nikkei is off 9.3%, pressured by Japan’s complete dependence on Middle-East crude and a yen that weakened past 152 per dollar.

“The market was long globalization and short U.S. exceptionalism,” says Vincent Cignarella, global macro strategist at MarketWatch. “All it took was a supply-chain choke point getting bombed to unwind that bet.” Cignarella notes that Brent crude futures leapt 14% in the first trading sessions after hostilities began, an immediate tax on current-account deficit countries in Europe and Asia.

Safe-haven playbook re-emerges

History shows investors rarely fight the last war—they flee to the last refuge. During the 1990 Gulf War, the S&P 500 outperformed the MSCI World ex-US index by 8 percentage points in the first quarter. A similar pattern played out after 9/11 and during the 2003 Iraq invasion. Each episode lifted the dollar and Treasuries alongside domestic equities, a trifecta now repeating in 2026.

Currency moves amplify the divide. The dollar’s 2.7% surge since late February has shaved roughly 150 basis points off euro-denominated returns for American holders of European stocks, according to Bank of America strategists. That math partly explains why net inflows into international funds flipped to outflows almost overnight.

Bottom line: the macro rationale for diversification has not changed, but the tactical calculus has. Until energy markets stabilize, investors show little appetite to bottom-fish abroad.

Energy Shock Tilts the Scales

Crude markets are flashing the kind of signals that derail economic forecasts overnight. Brent jumped from $71 to $81 a barrel in the week after the first strike, and European natural-gas futures surged 22%, according to ICE data. For economies that import more than 60% of their energy needs, the spike acts like an immediate tax on consumption.

Europe’s plight is illustrative. Germany spends roughly 3% of GDP on net energy imports, double the U.S. share, IMF figures show. A sustained $10 rise in Brent could shave 0.4 percentage points off euro-area GDP growth within a year, Oxford Economics estimates. Equity strategists translate that hit into earnings: every sustained $1 increase in Brent cuts European corporate profits by roughly 0.3%, per Goldman Sachs.

Japan faces an even steeper drag. The archipelago imports 94% of its primary energy, according to the Ministry of Economy. A 10% yen depreciation coupled with a 14% oil rally therefore delivers a double shock—higher import costs and weaker purchasing power. Little wonder the Nikkei has underperformed the S&P 500 by more than 400 basis points since hostilities began.

Corporate guidance turns cautious

Early earnings commentary confirms the gloom. BASF, whose Ludwigshafen complex relies on steady gas flows, warned that “every sustained €10 per MWh increase in European gas prices trims EBIT by roughly €200 million.” With front-month TTF gas up €8 since February, the chemical bellwether’s margin cushion is evaporating fast.

Airlines are next in line. Frankfurt-listed Lufthansa has already trimmed capacity guidance for the summer schedule, citing jet-fuel prices that touched $820 per metric ton, a level last seen after Russia’s 2022 invasion of Ukraine. Investors have responded by selling shares of European carriers en masse; the Bloomberg Europe Airlines Index is down 12% since late February.

Energy exporters, by contrast, are enjoying a windfall. Norway’s Equinor has rallied 8%, and London-listed Shell has added 6%. Yet energy accounts for barely 12% of MSCI Europe’s market cap, too small to offset the drag from energy consumers that dominate the index.

Dollar Comeback Punches Hole in FX-Linked Returns

Currency traders have witnessed a textbook flight-to-quality. The dollar index, which measures the greenback against six major peers, leapt from a February low of 102.9 to a peak of 105.7 within two weeks, erasing nearly all of this year’s prior decline. For U.S.-based investors, the surge has clipped returns on unhedged foreign holdings by roughly 1.5 percentage points for every 1% dollar gain.

The speed of the reversal caught many off guard. Asset-manager surveys by BofA Securities in early February showed allocators held their largest underweight in U.S. equities since 2013, expecting a softer dollar to flatter overseas earnings. Instead, the greenback’s safe-haven premium has re-emerged, dragging the euro back below $1.08 and pushing the yen past 152 for the first time since 2023.

“Currency-hedged ETFs are suddenly back in vogue,” says Alejandra Grindal, chief economist at Ned Davis Research. Assets in the WisdomTree Europe Hedged ETF jumped $1.2 billion in the week ended 14 March, the fastest inflow since the fund’s 2014 inception. The move underscores how investors still want foreign exposure but not the FX risk that accompanies geopolitical flare-ups.

Carry trades unwind

Rising dollar funding costs have also forced liquidation of popular yen-funded carry trades. Hedge funds that borrowed yen at 0.1% to buy higher-yielding euro-area bank shares now face losses on both legs of the trade as the yen strengthens and European equities sink. Goldman Sachs prime-services data show leverage in Japanese accounts down 18% since late February.

Policy signals reinforce the greenback’s allure. While the Fed has paused rate cuts, the European Central Bank is widely expected to lower its deposit rate by 25 basis points in April, and the Bank of Japan remains committed to ultra-loose policy until wage inflation exceeds 2.5%. Interest-rate differentials therefore continue to favor the dollar, making it both a safe and high-yielding haven.

Are U.S. Equities Now the Only Game in Town?

With Europe and Asia on the back foot, Wall Street has regained its default-setting status. The S&P 500 trades at 19.3 times forward earnings, a premium to the 14.2 multiple on MSCI Europe but below the 10-year average of 20.1, FactSet data show. Relative to bonds, the equity risk premium on U.S. shares stands at 320 basis points, above the 20-year mean of 290 bps, suggesting room for further multiple expansion if earnings hold up.

Sector composition helps. Tech and health-care giants—Apple, Microsoft, Johnson & Johnson—derive the bulk of revenue domestically and boast balance-sheet cash that suddenly looks attractive when geopolitical uncertainty spikes. The S&P 500 Information Technology sub-index has fallen just 3.8% since the Iran conflict began, outperforming Europe’s tech basket by more than 500 basis points.

Share-buyback programs provide another cushion. U.S. companies announced $281 billion in repurchases during the first quarter, the highest since 2018, according to S&P Dow Jones Indices. Overseas firms, constrained by tighter leverage ratios and EU capital-return rules, have announced only €42 billion in buybacks over the same span.

Valuation gap narrows

Yet bulls warn against complacency. The 12-month forward price-to-book ratio of MSCI Europe relative to the S&P 500 has fallen to 0.62, the lowest since 2004. History shows that when the discount reaches extreme levels, subsequent five-year returns for European equities often outpace those of U.S. peers by 3–4 percentage points annualized, according to Research Affiliates.

Meanwhile, earnings expectations are converging. Analysts forecast 8% S&P 500 EPS growth for 2026, down from 11% in January, while European profit growth estimates have slipped only modestly to 6%. If energy prices stabilize, the earnings gap could close quickly, leaving U.S. valuations vulnerable to a catch-up trade in foreign shares.

What History Says Happens Next

Studying 25 military conflicts since 1960, Deutsche Bank finds that equity markets outside the U.S. underperform by an average of 5.5 percentage points in the first three months but recoup two-thirds of that gap within a year if oil prices retreat below pre-conflict levels. The key variable is duration: wars lasting less than six months produce full retracement, while prolonged engagements leave lasting scars on non-U.S. growth.

Central-bank reaction functions also matter. In 1991, coordinated rate cuts by the G7 helped global indexes bottom within six weeks. Today, the Fed has less room to maneuver with fed funds at 4.6%, but the ECB and BOJ still possess easing capacity that could cushion overseas markets if inflation expectations remain anchored.

Currency stabilization is another catalyst. BNP Paribas models suggest that every 1% decline in the dollar index adds roughly 0.4% to euro-area equity returns for U.S.-based investors. A partial unwind of the greenback’s recent rally could therefore restore the relative appeal of foreign shares without requiring a surge in local earnings.

Structural case still intact

Long-term drivers haven’t disappeared. Demographic tailwinds in India and Indonesia, reshoring incentives in Mexico, and green-capital investment in Europe all point to faster non-U.S. GDP growth over the coming decade. IMF forecasts see emerging economies expanding 4.1% annually through 2030, double the 2% pace expected for advanced nations.

For investors with multi-year horizons, the current selloff may prove a rare entry point. Vanguard’s 10-year capital-market assumptions lifted expected annual returns for non-U.S. developed equities to 7.2% from 6.5% before the conflict, thanks to lower starting valuations. The analogous U.S. forecast stayed flat at 5.4%, leaving a 180-basis-point edge in favor of overseas markets.

Bottom line: history cautions against abandoning diversification at the very moment geopolitical fear peaks. If energy markets calm and the dollar eases, international equities could swiftly reclaim their intended role as portfolio outperformers.