The old EM playbook is out of date

Many investors still view emerging markets (EMs) as highly cyclical economies that depend heavily on global trade, commodities, and demand from developed-market consumers. These markets are often perceived as especially vulnerable to political and geopolitical instability, a strong US dollar, and capital outflows during periods of market stress.

The past few years have challenged many of those assumptions. True, EMs have faced a difficult backdrop—including increasing global tariffs, volatility in oil prices, and rising geopolitical tensions—yet emerging market equities have not only weathered these headwinds but have continued to outperform. Last year, EM equities led both US and international developed markets. The same is true so far this year also, which is particularly remarkable given the overhang of the war in Iran. 

It seems likely to us that this EM outperformance could continue for quite a while. Why? Well, first of all, EM equity outperformance has tended not to be a one-year event but, instead, a multi-year phenomenon. Secondly, there are a number of favorable tailwinds that may benefit the asset class right now. The countries that make up the EM universe are highly diverse and not all can lay claim to all of the benefits listed below, but this resilience reflects the significant structural transformation that’s taken place across many of those economies over the past two decades, including:

• Stronger fiscal positions
• More stable and disciplined monetary policies
• Improved corporate governance standards
• Rising domestic consumption and increased trade among emerging markets
• Significant growth of the middle class

How technology and innovation are changing the picture

In some cases this means that EM countries have “leapfrogged” their developed market counterparts in the past few years – think fintech, electric vehicles, renewables, and electrification. At the same time, the rapid global expansion of artificial intelligence may be offering these same countries a useful tailwind. 

Consider the scale of AI-related investment by leading US tech companies: more than US$670bn this year alone, with that sum projected to rise to nearly US$790bn next year. As investors seek to benefit from this unprecedented wave of spending, attention has begun to shift beyond the headline AI platforms toward the companies supplying the products, components, and raw materials that make the buildout possible.

This is where EMs come in. They are home to many of the critical players in the global AI supply chain, from leading technology firms across Asia to materials and commodity producers in Latin America, including lithium, copper and uranium. In other words, EM companies are not merely exposed to the AI theme; they are helping to build the infrastructure that will support its global rollout.

All of this is to say that today’s EM index looks very different from the one investors knew even just a decade ago. No longer dominated solely by the regulated industries like banks, energy companies, and commodity producers, the universe now includes globally important technology leaders that sit at the center of semiconductor manufacturing, memory production, and the advanced technology infrastructure underpinning the AI revolution.

Valuations are a tailwind too

In addition to improving fundamentals, we believe EMs also offer a more attractive valuation opportunity than many of their developed market counterparts. In US equities, finding companies with strong earnings growth at relatively low valuation multiples has become increasingly difficult. Not so for EMs: here we can find companies that continue to trade at a meaningful discount to the S&P 500—despite forecasts of faster earnings growth. Currently, EMs trade at an approximately 46% discount to the S&P 500 on a trailing earnings basis. Earnings-per-share revision momentum has also been notably stronger in EMs this year compared to the S&P 500.

Not your parents’ emerging markets

Emerging market equities can provide investors with access to growing companies operating in secular growth industries. Yes, there continue to be risks: geopolitical tensions, debt and fiscal profligacy, elections, commodity price volatility, and now AI concentration to name just a few – but the landscape has changed dramatically from just a few years ago. Improved external balances, higher currency reserves, lower inflation baselines, and now innovation all can help mitigate those risks. 

For long-term investors, the implication is clear: EMs may deserve a fresh look. Stronger fundamentals, attractive valuations and a growing role in the global technology and AI supply chain suggest the opportunity is broader than the old cyclical playbook allows. Risks remain, and selectivity matters, but the case for EM equities is now as much about long-term structural change as short-term momentum. Long relegated to a supporting role in the global economy, EMs are now helping to shape the next phase of innovation.