Emerging market (EM) equities started 2026 with renewed momentum, extending the relative outperformance seen last year. EM equities are up roughly 5% year-to-date in USD terms and have now outperformed developed markets (DM) by approximately 15% cumulatively since early 2025. While notable, this recovery still only offsets a fraction of the roughly 47% relative underperformance EM suffered versus DM between 2018 and 2024, suggesting the move may be early rather than late. Several forces argue that this is not merely a short-term bounce, but the beginning of a more durable regime shift.
First, the policy backdrop remains supportive. Unlike prior cycles, EM central banks entered this phase with greater credibility and fiscal discipline. Of the 23 EM central banks tracked by JP Morgan’s research team, 14 are still expected to cut interest rates further, while most others remain on hold. Crucially, even if DM sovereign bond yields were to rise episodically, EM yield and credit spreads versus DM continue to tighten, suggesting improving relative funding conditions rather than stress.
Second, the dollar is no longer a headwind. Dollar weakness in 2025 was among the largest on record, and historically this has been a powerful tailwind for EM assets. Looking ahead, the dollar may remain constrained by a potential dovish tilt from the Fed, subdued inflation, particularly if oil prices remain well behaved, and an evolving Fed reaction function amid upcoming leadership changes. A continued recovery in EM currencies would further reinforce the case for EM equities.
Third, China is still positioned for upside surprises. Investor skepticism toward China remains deeply entrenched, with most market participants discounting meaningful fiscal support. Yet pressure is mounting for policymakers to act, particularly as domestic demand remains weak and leverage appetite among households and corporates is limited. Policy emphasis appears to be shifting toward consumption-focused measures – including trade-in subsidies, pension increases, birth incentives, and childcare support – explicitly reinforced by the 15th Five-Year Plan’s call for a “notable increase in the consumption rate.” Against extremely depressed expectations, even modest follow-through could surprise positively.
Fourth, EM is participating in secular growth themes, notably AI, at more attractive valuations. EM AI-linked equities, particularly in Asia, have outperformed U.S. AI baskets in recent months, while still trading at meaningfully lower multiples. Hardware-focused names have benefited from improving pricing power and demand visibility, and earnings momentum continues to build.
Finally, valuations, earnings, and positioning all align. EM equities trade at approximately 14x 12-month forward earnings, a 32% discount to DM versus a long-term average discount closer to 27%. Importantly, this is not just a valuation story. EM earnings revisions are now positive relative to DM, following roughly 14% earnings growth last year. Despite improving flows, EM remains under-owned relative to benchmarks, leaving room for further reallocation.
After years of caution, the case for EM appears fundamentally stronger. A supportive policy mix, weaker dollar dynamics, improving earnings momentum, and low investor positioning create a backdrop in which EM equities may continue to outperform developed markets through 2026. In line with this, we have recently increased our EM exposure via our core ETF strategies.
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This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
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The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
