Can emerging markets keep partying on?

Should investors be paying more attention to emerging markets again? Chris Duncan investigates.

Emerging markets have been partying like it’s 2017 – the last time they delivered an annual return above 30%. 

Whether they will be popping champagne corks at the end of December remains to be seen but, having returned 31% year-to-date, emerging markets are on the dance floor and busting a move.

For many investors, it’s not before time. Emerging markets have gone nowhere for nearly two decades.

As Fidelity’s Tom Stevenson recently pointed out, there have been face-ripping rallies along the way: Chinese stocks rose seven-fold in the mid-2000s, for instance. But that only gave emerging markets a high base from which to underperform. Since then, capital has only had eyes for the US. 

Recent years have not inspired. Emerging market’s 8% return last year was dreary compared to many developed markets, and 2023 was not much better (up around 10%). Returns in 2022 (-19.7%) were best viewed from behind the sofa, through cracked fingers, though few markets bar the UK fared dramatically better.

It was 2021, however, that was the real kicker: the MSCI EM Index returned -2.2% while the MSCI World soared 22%. UK stocks, in USD terms, delivered more than 18%.

What’s changed this year?

The weaker dollar hasn’t hurt. While it’s reclaimed some ground since the middle of the year, the US dollar index is down almost 8% in 2025.

That’s helped emerging market dollar returns as well as those countries with dollar-dominated debt. It’s also boosted commodity prices, a key emerging market export. Not unhelpfully, Goldman Sachs Research expects the US dollar to depreciate against other major currencies in the coming months. 

Central banks in emerging markets now enjoy newfound monetary policy flexibility, with the US Federal Reserve back in rate cutting mode. That’s meant, for the first time in a long time, they are not obliged to keep their policy rates artificially high to maintain currency stability. Fingers crossed Jay Powell dons his Santa outfit and gifts investors another rate cut at December’s meeting of the Federal Open Market Committee. 

Can emerging markets keep performing even if Powell turns into the Grinch? There are reasons to think it can.

For one thing, its stocks remain cheap relative to developed markets. While investors have grown jittery about nosebleed US equity market valuations, the MSCI EM Index is trading on a forward P/E of around 14x. While that’s not screamingly cheap (it’s around the historical average) it’s still a long way south of the S&P 500 (forward P/E around 22x) and MSCI World (around 20x).

Nor is this a pure valuation play. Some emerging markets (including South Korea and Taiwan) are a major beneficiary of the AI boom and insatiable thirst for semiconductors, offering investors a chance to invest in the theme without having to pony up the premium valuations associated with the biggest US beneficiaries. 

A company like Alibaba is a case in point, argues Jon Alvis at Aubrey Capital Management. Best known as an ecommerce powerhouse, Alibaba has become a global leader in cloud and AI, with a world-class AI model.

All of this has been built at much lower cost than its US rivals, who now face difficulty accessing power for their burgeoning datacentre pipelines. Alvis calculates that OpenAI’s Stargate Project alone will ultimately require the equivalent annual power consumed by the whole of New Zealand. But power demands are no problem for China, he says, ‘leaving a clearer runway for growth’.

AI observers have been paying China a great deal of attention since DeepSeek caused global gasps. Another marmalade-dropper like that could tip nervy investors into panic-sell mode. But it’s not just killer AI models developed market companies should fear. 

China has become a global leader in humanoid robotics – coming to a store near you sooner than you might like – and, increasingly, drug innovation.

The trade spat with the US injects an unhelpful dose of uncertainly, but China surely holds the better cards and it is becoming increasingly self-sufficient in key sectors. Having rewired supply chains since Trump’s first term, China’s exports to the US are just 15% on a bilateral basis.

Oversupply remains problematic but Beijing is determined to address it through its so-called ‘anti-involution’ measures. Boosting domestic consumption is the big prize, with China’s 35% household savings rate around double major economy averages.

Welfare reform is being introduced to unlock this pool of savings and boost domestic consumption, which would be a game changer for a country yet to shrug off deflationary pressures.

Importantly, though, it’s not only China implementing reform: many other emerging markets, like Korea, are seeking to improve governance standards and build better financial systems. And by and large, emerging market fundamentals are attractive relative to developed countries, with less debt and lower inflation.

Clearly, there are risks to navigate. But as the US lurches from one counterproductive policy to another, eroding faith in its credibility, capital will continue to flow elsewhere. With Europe’s appeal waning, the punchbowl doesn’t seem likely to be removed from the emerging market party anytime soon.

DISCLAIMER

This article is produced for general informational purposes only. It should not be construed as investment, legal, tax, mortgage or other forms of financial advice. If in any doubt about the themes expressed, consider consulting with a regulated financial professional for your own personal situation. Past performance is no guarantee of future results. Investments can go down as well as up and you may get back less than you started with. Investments are speculative and can be affected by volatility. Never invest more than you can afford to lose. For more information visit ⁠⁠⁠www.fca.org.uk/investsmart⁠