Emerging Market Equities: Climbing the Wall of Worry

Emerging market equities are behaving differently during this latest wave of tariff-based volatility. In this article, Senior Portfolio Manager Chris Laine looks at what’s driving EM performance despite some significant headwinds, and shares his insights on positioning in the asset class.

Having worked in emerging markets for nearly 31 years, I have seen my fair share of volatility. More often than not, this volatility started from within EM based on policy mistakes, accidents, political issues, etc. However, during this latest period of volatility, let’s call it the ‘tariff trauma’, emerging markets are behaving rather differently.

News Flow, Overall, Remains Poor

We can’t pretend that 2025 has been a basket full of sugar plums for emerging market equity investors. In fact, it has been generally a drip feed of bad news (the latest tensions between India and Pakistan is another unhelpful development). Nonetheless, there are a few bright spots (Central Europe, a bounce in Latin America, and some interesting Chinese tech innovation) that have been just enough to keep investors in their seats – in aggregate – to manage a degree of outperformance against developed markets in 2025. (+6.2% for MSCI Index YTD versus about 1.0% for developed markets)*. However, this performance has in the words of my colleague, Laura Ostrander, been more “push” than “pull.” Let me explain.
*Source: MSCI, Factset, as of April 30, 2025.

For the moment, EM appears to be benefitting largely from a “push” trade as capital has left the US, versus a more optimistic “pull” scenario - suggesting fundamentals are accelerating in EM equities more broadly. There are signs here and there of some “pull” from EM – in markets noted above – but more is needed.

The Push: The US Looked Like an Emerging Market in 2025 (for a short period)

In a typical emerging market crisis, there tends to a distinct pattern of investor behavior - sell first and ask questions later. All the assets of a particular country are sold: Equities, bonds, and the currency. This is the opposite in developed markets, especially the US. When there are problems in the economy or financial markets, normally one sees an asset allocation trade – sell stocks, buy bonds or T-bills – or other US dollar-denominated assets. Part of the reason for this has been that the US dollar is the reserve currency, but it’s also due to the broad resilience of our economy, capital markets, and responsiveness of our regulators. It is rather odd that all US assets are selling off during the peak stress period, and if continued, it would be a rather ominous sign. Suffice it to say, I have seen this movie before and it doesn’t end well – especially when threats are made against the central bank. Given the United States runs significant twin deficits, it is best not to run the risk of a sudden stop if capital flows sharply reverse. It appears the administration has adopted a more pragmatic and engaging policy and markets have responded (see Figure 1).

Can Emerging Markets Shake Off Aggressive US Policy?

Let me state for the record that I believe that tariffs are almost always the wrong policy tool to address trade imbalances. There are better ways/methods/policies to use to help improve the productivity of the entire economy (reducing healthcare costs, legal/tort reform, improving the savings rate, and perhaps a bit of light industrial policy. In my view, broad tariffs by themselves are usually a bad solution – even using them bilaterally as a negotiation tools can be risky. In command economies, such as China, the ability to use stronger administrative measures in place to react to shocks allows them, at least in the short-term, greater flexibility.

It was often said, that when the US catch a cold, EM gets the flu (or worse). Even in market environments such as the GFC, emerging markets underperformed substantially. While the price action in developed markets began first, it didn’t take long until EM was affected – both through the bank/credit channels, drastically reduced commodity prices, and global trade volumes falling. An analysis of historical crises would suggest that inevitably EM equities fare poorly during heightened periods of volatility.

The Big Question: Is it Different This Time?

Answer: There are signs that it might be, but it is really too soon to say. In April, emerging market equities (MSCI EM) were up about 2% versus 0.3% for the US equities (the S&P 500). EM currencies (as defined by the MSCI index, are up about 0.7% vs the dollar).* While those calling this the end of the era of US exceptionalism are a bit premature, it seems to be that the US is just becoming a little less exceptional and that long-term investors who have made tons of profits investing in the US are using the current volatility to hedge their bets. EM equities have, at the margin, benefitted from this reallocation (it should be noted European stocks have gotten the lion’s share of US outflows).

*Source: MSCI, Factset, as of April 30, 2025.

Current Positioning for Risk On AND Risk Off?

In this environment where intraday volatility is at or near record levels, caution is warranted. The quote that “only fools rush in where angels fear to tread” rings true to me here in the spring of 2025. Our investment signals are diversified (value, quality, sentiment, and catalysts) and we make heavy use of risk controls and strict portfolio construction parameters. What separates the long-term investors is that they try and looks through short-term volatility and stay true to the investment signals that have had positive payoffs over the long term.

Macro dispersion has been extremely high in 2025, but it is – in my view – an idiosyncratic risk factor, not an alpha source. Best not to place too many positions on macro here – it forces you into a guessing game where the only answer is ‘Who knows?’. This is the time to lean into your risk controls.

If there is a silver lining in the current situation, it is that the laws of economics and finance need to be respected and current policy appears to be moving in a better direction. With that backdrop, emerging markets equities (broadly) can continue to climb the wall of worry.