Emerging markets: The forces shaping a potential multi year trend

After several years of being firmly out of favour, the MSCI Emerging Markets Index delivered a total return of more than 34% last year compared to 21% for the MSCI Developed World Index¹. The question now is whether emerging market stocks can continue to outperform developed markets in the coming years. We believe they can, thanks to several structural reasons and cyclical factors.

Importantly, the case for emerging markets is as much, or perhaps more so, about the case for reducing large positions in the US, as it is about the positives we see across the EM region itself.

Valuations expected to adapt to a change in narrative

Emerging market equities have long traded at a discount to their developed market counterparts, especially in the US. Valuation gaps can widen for a long time but, not forever. There needs to be a catalyst for valuation gaps to narrow and we see several catalysts now.

Over recent years, many emerging markets have seen a lower growth trend, and it appears that China is reducing its growth forecasts for the future. However, we anticipate a stronger global backdrop in 2026, and think we are approaching the nadir in growth in many emerging markets. It is not just growth, but rather the growth-inflation mix in emerging markets that now looks much better in many emerging markets than in many developed market nations which enables EM central banks to cut policy rates. That should be a positive for emerging market debt and equities alike.

The cyclical trigger for this gap to narrow occurred in 2025 as market participants began to question the US exceptionalism narrative that has persisted for many years. Unconventional trade policy from the US has caused global trade routes to shift — but not collapse. Many emerging markets are showing themselves to be adaptable to this changing order.

Broader changing relationships in the US, including the positive correlation between US stocks and bonds now has investors searching for alternative means of diversification. In our view, emerging markets stocks and bonds can offer those diversification properties.

Asian companies poised to benefit from artificial intelligence (AI)

The narrative around AI is evolving. No longer are US AI names being rewarded without question for spending more while there is greater scrutiny being placed on companies whose business models might be disrupted by AI. Because of the valuation discrepancy it is US companies more than EM and EM Asian companies that are most vulnerable as that narrative shifts.

We do not think AI spending and datacentre build out is suddenly going to slow meaningfully. Companies are still committing to strong growth in capex. Assuming that does continue, many names in Asia, particularly in the hardware space can continue to benefit.

Some EM markets and stocks have risen strongly in response to the AI narrative, but many of these companies trade at significant discounts to their US peers. Hardware names have performed particularly well in Asia, supported by strong demand for memory linked to AI. Normally, high memory prices would encourage more supply and eventually bring prices down, but we’re not seeing any evidence yet of that happening. This supports the earnings outlook for key EM semiconductor players and for those wanting to play the AI theme at more attractive valuations, we believe EM offers more opportunities than the US.

Korean stocks performed very well last year, but the strength of earnings growth means they still trade at a discount to the broader EM index and a deep discount to developed markets on price-to-earnings multiples. Much of that earnings growth has come from Samsung Electronics and SK Hynix, which benefitted significantly from rising memory prices. These two stocks make up around 47% of the MSCI Korea Index.

The AI build out theme, greater defence and industrial spending in Europe, and stronger growth in the US in 2026 are likely to result in higher commodity prices, especially base metals, in our view. If we are correct, that provides another support for emerging markets, which have historically displayed a positive correlation with commodity prices. Emerging market corporate earnings tend to be related more to metals than oil prices. Brazil, Indonesia, South Africa, and Chile are major producers and should benefit from higher prices.

A weaker US dollar supports emerging markets 

Emerging markets have historically tended to perform better relative to developed markets when the USD weakens. For much of the period since the Global Financial Crisis, USD strength has been a headwind to EM equity and bond performance.

The dollar's depreciation lowers the cost of servicing dollar-denominated debt, easing financial pressures and stimulating growth. EM funding costs have been moving lower. We note that J.P. Morgan Emerging Market Bond Index shows spreads over US Treasuries at the narrowest on record.

A weaker USD tends to benefit emerging market equities further by supporting commodity prices and attracting increased capital inflows from investors seeking potentially higher returns outside the US. 

We think the conditions are set for a multi-year period of USD weakness, as we saw in 2002-2007. 

• The USD fell heavily in the first half of 2025, as investors began to question the US exceptionalism narrative. Though the US Dollar Index (DXY) fell more than it did in 1973, the year the US left the gold standard, it remains overvalued on most measures including real effective exchange rates and purchasing power parity measures.  
• The change in narrative too means the USD is no longer being viewed as a haven currency, one that performs well in risk-off periods. Rather than a traditional USD smile, there is more of a USD frown today. The US administration has sent some mixed messages on the USD but in our opinion, we think the administration would prefer a weaker USD. 
• In addition to the changing perception of the US, we’re seeing a near-term falling of US policy rates in 2026, set against rising yields in Japan and an ECB that is likely on hold. Narrowing yield gaps mean the cost that foreigners pay to hedge their USD currency exposure on their US asset holdings should fall. Greater currency hedging would put downward pressure on the USD.

Historically a weaker USD has been a support for emerging market debt and equities. 

EM policies are becoming more friendly towards shareholders

A common lament we heard a few years ago was “China is uninvestable.” Some investors feared that their money was not safe in some emerging markets — never mind return on capital, investors worried about return of capital.

That is a valid fear, as those holding Russian assets in 2022 can attest. But in general, we think the uninvestable worries are wildly overblown, and we are now observing far more shareholder friendly policies across emerging markets, including China.  

Chinese authorities have sent clear signals in recent years that they want to see domestic investors invest in stocks and see the market as a means of wealth creation. 

• While we don’t think the Chinese household sector is suddenly going to accelerate, despite the authorities’ efforts to boost domestic demand, we note that these households have very large cash balances now and may continue building positions in their domestic stock market, which would likely provide some long-term support. And, lower domestic demand would likely be taken positively by the market. 

• The China Securities Regulatory Commission is considering higher compliance thresholds for mainland firms seeking a Hong Kong listing to reduce the risk that weak companies may damage global investors’ view of Chinese assets.

• Finally, after years of seeking to build out significant industrial capacity with little thought for return on capital, China’s anti-involution policies are aimed at improving margins and returns to shareholders. Change won’t happen overnight and there remains a lot of excess capacity in China, but the direction of travel is changing. 

It is Korea, however, that has been the standout with more friendly shareholder policies. Politicians and policymakers in Korea are increasingly conscious of the (voting) public’s involvement in equity markets, either directly via investment accounts or via pensions. This has made improving market returns a political issue, increasing the incentive to reach for the corporate governance reform lever.

The Korean ‘value-up programme’ has been in place since February 2024 and was given fresh momentum in July 2025 when Parliament passed a revision to the Commercial Act, increasing the fiduciary duty of board members towards minorities. The aim of the program is to reduce the ‘Korea discount’ and attract foreign investors by fostering better corporate governance, capital efficiency, and increased shareholder returns through stronger dividends and buybacks.

Isn’t deglobalisation a headwind?

Emerging markets have traditionally relied on external demand to support their growth. They have tended to export to richer nations.  

A world in which the US is seeking to alter the terms of trade may therefore be seen as one where emerging markets struggle. The US will likely be a less important trading partner for many than it has been in the past — particularly for China. But as nations question whether they can trade with the US on reliable terms, that is pushing them to make new deals with other partners around the world. For example, the EU and India recently agreed to a broad reduction in tariffs. 

We note too that if we consider the FTSE All Share emerging market index, only around 15%² of revenues for those companies are generated in North America – it is intra emerging market trade that generates the bulk of the revenue. While diversifying away from the US would have hurt investors between 2009 and 2024, having less exposure to the US now could well be a good thing. 

Somewhat counterintuitively, the heightened geopolitical tensions and change in global relationships could be a positive for emerging markets now as it focusses the need on strengthening other relationships.

The start of a multi-year trend? 

Emerging market equities have lagged their developed market counterparts since 2009. 2025 saw a turn in performance, and that has continued thus far in 2026. We see good reasons to think this trend could persist, as it has done in long periods before. Across much of the EM space there are plenty of opportunities to be found and companies that may deliver upside surprises.

2026 is the Chinese Year of the Fire Horse, a year that should bring intense energy, rapid change and great ambition. We think that is an apt way to describe our outlook for emerging markets, not just China.

Emerging Market equities

Our Asian and emerging market equities team are experts in building diversified portfolios designed for long-term success. We invest across sectors and industries, seeking quality companies and capturing opportunities across emerging markets.  

• Invesco Asian Equity Fund 
• Invesco Emerging Markets Equity Fund
• Invesco Emerging Markets ex-China Equity Fund
• Invesco MSCI Emerging Markets UCITS ETF
• Invesco Emerging Markets Enhanced Equity UCITS ETF