Emerging Markets Quarterly Outlook Comfortably Bullish: Momentum heading into 2026, but balanced positioning is warranted

Emerging market (EM) equities are starting 2026 with renewed momentum, supported by a combination of macroeconomic tailwinds, some evidence of structural profitability improvements, and strengthening investor sentiment.

2025 EM equities recap: Very robust performance

At the start of 2025, EM investors faced a wide range of challenges, including:

• Tariff shocks. The Trump administration’s policy on tariffs was set to negatively affect EM economies.
• Chinese consumer declines. Chinese growth was looking “iffy”, and earnings growth, while steady, wasn’t particularly spectacular. 

However, these hurdles were overshadowed by three more powerful shifts:

• Pressure on the US dollar. Some cracks in the “king dollar” thesis created an opening for investors to look to hedge. Investors, who had been heavily allocated to U.S. assets for several years, had reason to reassess that positioning.
• AI business investment. The DeepSeek news in January perhaps wasn’t as much of a game changer as some argued, but it surely reminded investors that China is an extremely important player in the AI revolution (not to forget about Korea and Taiwan).
• Strong EM earnings. Corporate EPS was surprisingly solid, with 16% growth in 2025 (preliminary). More than 20% growth is expected for 2026, per FactSet.

Overall, EM equities had a fantastic 2025, posting a gain of +33.6—the best year versus developed markets since 2017 (the S&P 500 was up 17% and the MSCI World was +21%). Last year’s performance marked one of the best EM rallies since 2017. This year has started off strong, with the asset class rising 5%.¹

What comes next?

EM equities have all the ingredients for further performance upside

After EM currencies appreciated strongly against the dollar in 2025, weakening in the dollar could help boost EM economies in the coming year. In addition, still-light positioning in EM equities globally, and the potential catch-up of EM profits to DM profits, adds to the performance momentum.

“Sell America” sentiment and a still-pricey US dollar set the stage

Some market participants have posited that the US administration may pivot from its unpredictable approach to US foreign policy, and instead focus on domestic issues in the run-up to the midterm elections. The first part of January suggests that this may have been a false hope. At the start of 2026, we think reallocations away from the US remain likely—especially as the US dollar remains quite expensive (in real terms) versus history. Since the end of the gold standard, the US dollar has only been this strong a few times.² Thus far, investors have mostly been picking up dollar hedges, versus selling dollar assets specifically (Figure 1). However, there is risk here, and it will favor non-US assets for some time.

Profitability Convergence?

An enduring (and negative) theme that has kept investors on the sidelines in EM stocks is that they have been under-earning their US counterparts for some time. The inertia of the EM underweight has proven to be a solid trade through last year, but investors we speak to still view EM equities as a trading dynamic. On the flip side, we are starting to see some profit convergence (particularly in the major tech-related names) that is getting investors’ attention. This is occurring as valuations remain high for US assets and Europe remains in the crosshairs of geopolitical pressure.

Consensus is expecting 21% EPS growth in EM equities this year, which is substantially ahead of both the US and developed market (DM) (+15% and +13%, respectively).³  The more that EM can out-earn World ex US, and inch closer to World (Figure 2), the long-term investment case will build itself and EM equities could enter a new cycle of sustained strength.

Investors are still offsides

Despite momentum throughout last year, most clients did not participate in the 2025 rally. According to State Street Investment Management data, aggregate positioning shows that global investors are still underweight EM. They are less underweight to be sure (there were especially large moves in Chinese exposure), but nonetheless, the conclusion is clear. Investors, broadly speaking, did not benefit from EM’s strong performance last year.

Moving forward, there is still potential for new money to enter the asset class. Digging deeper, EM Equity funds saw strong inflows (roughly $30 billion in 2025—the strongest since the post-COVID recovery). However, under the surface, the divergence was clear. The optimism was most prominent with ETF buyers, as EM ETFs saw inflows of nearly $88 billion. Meanwhile, non-ETFs saw outflows of $58 billion.⁴

The way forward: Keep value balance in your EM exposures

Valuations remains one of the strongest arguments in favor of EM equities. Despite the rally in 2025, EM equities still trade at a significant discount to DM equities. This valuation gap has narrowed somewhat, but remains wide enough to attract global investors seeking diversification and growth at reasonable prices. However, need to consider:

• Valuation dispersion. We continue to focus on the wide valuation spread within EM equities. While this is not unique to EM—far from it—it makes sense for investors to keep some ballast in their exposures. The difference between the most expensive stocks and those in the middle are at near record levels.
• Value assessment. We have a lot of respect for many of the high-growing firms, but at the same time, don't want to overpay for them.
• Quality focus. Investors can benefit from keeping some value—quality value—in EM holdings.

Our current positioning

By region

We continue to favor Chinese stocks, largely funded by underweights in India. We continue to think India is one of the best investment stories over the medium term (five years), but the ingredients are just not aligned for this year. China has better value, momentum, and larger underweights to attract capital (and a more resilient FX). We are neutral to slightly underweight EMEA; the smaller markets may be tricky in 2026 after some big gains. Low oil prices may create some good entry points in the Middle Eastern markets, but we aren’t ready to buy.

By sector

Within the tech space, we also favor Korea and Taiwan. IT, financials, and communication services are the preferred sectors (funded by underweights in healthcare, utilities, and energy). We also prefer large caps over small caps this year.