The last week of May wasn’t pretty for stocks globally, but international markets may outperform U.S. equities based on economic and company fundamentals.

Almost every major market was down — one prominent exception was Japan — and the minor ones were down more. China experienced a 6.5 percent hiccup mid-week that everyone seemed to want to see as, at least, the beginning of the end of that bull market so it probably was nothing more than a buying opportunity for those willing to buck the consensus.

The U.S. stock market has been struggling all year and unless the economic data start turning up soon, it seems likely to continue. I say that because more quantitative easing doesn’t seem to be an option and the Federal Reserve is intent on hiking rates sometime this year; monetary policy is not going to be a tailwind.

The discount rate isn’t going any lower. And so, if stocks are to advance, it will be because earnings are turning higher — something that has been missing for the last two quarters or because investors are willing to pay an even higher multiple than they already are for U.S. stocks. Multiple expansion is possible but I’d just point out that higher P/Es can be achieved without stock prices rising. Less E accomplishes the same thing as more P.

And yes, stock buybacks could potentially be enough to keep EPS rising even if overall earnings aren’t but there is a limit to the stock buyback game. At some point — and I think we are rapidly approaching it — balance sheet concerns will outweigh the desire to hit the quarterly earnings number. Or at least I hope so.

Earnings Peak

Corporate earnings appear to have peaked for now. The GDP update Friday showed corporate profits, after adjustments for inventory and capital consumption, were down 5.9 percent after a smaller drop in the fourth quarter. The economy contracted in the first quarter by 0.7 percent if you believe the BEA and their seasonal adjustments and the second quarter so far isn’t looking a lot better (And by the way, does Canada have the same seasonal adjustment issues with GDP?) so earnings gains are going to be hard to come by.

The economic data released last week continued the trend of less than expected and hoped for. There were some positive exceptions as usual and I wouldn’t minimize them. The data on housing — new home sales and pending home sales — looked pretty darn good. And the durable goods orders did show a significantly better read on capital goods for the second month in a row – although the overall trend is still down for durables – which might bode well for capital spending.

But the manufacturing side of the economy is still struggling mightily with the slowdown in the oil patch. The Dallas Fed manufacturing survey was a complete disaster at -20.8. While the Richmond Fed’s survey posted a positive number – barely at 1 – the Chicago PMI Friday was a bucket of cold water for the optimists.

The weak economic environment has kept a cap on U.S. stocks so far this year. Despite the headlines about all-time highs, the S&P 500 is up all of 0.7 percent in the past three months and a whopping 2.9 percent in the last half year.

Global Markets

By contrast, foreign markets have done much better. EAFE, a broad international index, is up over 5 percent while China, Japan and Europe have all done even better over the last six months. Part of the reason for that is merely the recent correction in the dollar index but it is also due to growth prospects that are improving, at least relative to the U.S.

Yes, China is still slowing but even at a reduced pace it is growing faster than almost anywhere in the world with the possible exception of India. And yes, Japan’s domestic economy still has problems a weaker currency won’t cure but corporate earnings are growing faster there than any other developed economy.

There’s hope in Spain, where first quarter GDP grew 2.7 percent year over year and 3.6 percent annualized from the fourth quarter. And even Italy managed to post a positive GDP growth rate in the first quarter although it was pretty meager. Of course, all these economies are dependent to one degree or another on the U.S. so if we fall into recession — something I don’t see yet — all bets are off.

In any case, none of this — the recent underperformance of U.S. shares — is surprising to anyone who has been paying attention to the debate about U.S. stock valuations. The bearish argument has been that high profit margins make valuations look less extreme but when margins are normalized, valuations — and risks — are near all-time highs. There has been a robust debate about why margins are high and whether they will mean revert and to what level but the entire debate centers around margins. The bulls have argued that margins are high for good reasons and need not fall back to the long-term mean — it’s different this time.

The bulls have been winning that argument because stocks have been going up and margins have stayed stubbornly high but that may be changing. In the big picture macro sense, margins have peaked already and with the most recent GDP report have now fallen from more than 10 percent to slightly less than 8 percent.

The drop for the S&P 500 hasn’t been as extreme; operating margins peaked in the third quarter of 2014 at 10.1 percent, fell to 8.98 percent in the fourth quarter and 9.38% in the first quarter.

The bottom line is that margins fall during recessions and slowdowns and while recession seems unlikely right now, the slowdown is obvious. With productivity growth stalled and top line growth stagnant, higher US margins and earnings seem unlikely.

In the U.S. we have waning economic growth (the widely expected second-quarter rebound is missing so far), falling sales, declining earnings estimates and margins contracting from very high levels.

Compare that to Europe where growth is turning up (tentatively), margins are already compressed and earnings estimates are rising. Margins haven’t started to rise yet — and may not — but at least there is the possibility of some upside from current depressed levels. And actual earnings have yet to meet those optimistically rising estimates so don’t break out the bubbly yet. But overall, it seems the two areas are on opposite sides of the cycle.

In Japan, returns on equity and profit margins are among the lowest in the world and roughly half the S&P 500’s. Part of Abe’s revival plan is to get companies to target higher equity returns and the effort is paying off. It isn’t just a weaker yen that is driving Japanese corporate profits. As I’ve said before, Japan has entered a secular bull market.

U.S. stocks have spent the last six months going nowhere fast while international markets have taken the lead. The shift is being driven by changing fundamentals or at least a perception of changing fundamentals. That is being reflected not only in stock market performance but also in the currency markets.

Despite last week’s rally, the dollar peaked in March. Unless U.S. economic data pick up and the expected second half rebound becomes reality, the dollar’s big rally is probably over. If that is true, the outperformance of international assets seems set to continue.