International equities have outpaced U.S. stocks over the past four years. And barring some year-end meltdown, the trend looks set to continue in 2006. This year through November 10, the S&P 500 was up 10.6% — a respectable, even praiseworthy number — but quite short of the 17.8% advance (in U.S. dollars) over the same period that was posted by the MSCI EAFE index, the leading benchmark for international developed equities. Moreover, the MSCI Emerging Markets index was up 19.3%.

What is causing this outperformance — and can it continue?

Some of the strength can be attributed to a weaker U.S. dollar, attractive equity valuations, and healthy profit margins, helped by ample global liquidity and corporate restructurings induced by M&A activity. But there’s another key factor at work; namely, the rest of the world is beginning to look more like the U.S.

America’s robust gross domestic product (GDP) growth over the past few years has been fueled largely by consumers’ appetite for everything from iPods to hybrid autos to home refurbishments. But as American spenders are tightening their purse strings, falling unemployment in developed countries is causing German, French, and Japanese consumers to loosen theirs.

More significantly, rising per capita income in emerging markets – which, according to the International Monetary Fund, account for 27% of global GDP – is dramatically increasing emerging middle-class demand for such things as autos, branded apparel, home appliances, packaged goods, and consumer electronics. This trend extends beyond products, however, and as employment rates and disposable income rise, consumers are demanding access to financial services and health care as well.

This growth in domestic consumer demand in Europe, Japan, China, India, Latin America, and Eastern Europe lessens the reliance of those economies on the American consumer, thereby allowing them to “decouple” from the United Sates and better weather a U.S. slowdown.

As a result of this decoupling, independent research firm Global Insight projects that an estimated 1% reduction in 2007 U.S. GDP growth should have a relatively benign effect on world economic growth. Specifically, the firm estimates that world GDP growth would be reduced by only 0.6%, with the impact on key international economies like the U.K., Germany, France, Japan, and China being even smaller.

While S&P expects the U.S. economy to slow from GDP growth of 3.3% in 2006 to 2.3% in 2007, we expect global growth to be much more resilient, chalking up a 3.3% advance in 2007, down only modestly from the 3.9% increase projected for 2006. S&P Equity Strategy believes that the resilience of the world economy, given the decoupling scenario, will continue to be positive for the sales and earnings of multinationals. In addition, low valuations relative to U.S. stocks, along with our expectation of continued U.S. dollar weakness in 2007, lead us to believe international equities will continue to outperform.

The Standard&Poor’s global asset allocation dedicates 20% to international equities. We recommend a 15% allocation to developed foreign markets, represented by iShares MSCI EAFE (EFA), and a 5% weighting in iShares MSCI Emerging Markets (EEM)