Both emerging market (EM) equities and debt have delivered strong performance this year. We think the trend will continue. Thus we maintain a preference for EM assets in our multi-asset portfolios, supported by three key macroeconomic tailwinds- solid global growth, easing U.S. monetary policy and a softening U.S. dollar.

Solid global growth

We expect global growth to return to trend levels by 2026, providing a positive backdrop for emerging market assets. Despite some signs of labor market weakness, recession risks in the U.S. seem contained, largely due to resilient consumer demand. Our base case sees the pace of U.S. growth accelerating to 2% in 2026, underpinned by fading tariff impacts, expansionary fiscal policy and easier financial conditions. The global manufacturing cycle has also proven more robust than anticipated, with broad-based strength in global capital expenditures.

Fed easing

We think the Federal Reserve (Fed) will continue to ease policy in December and we see  the potential for additional rate cuts next year. Ongoing monetary easing should create room for further policy accommodation in select emerging markets, supporting local financial conditions and asset prices. Historically, when Fed rate cuts occur alongside a non-recessionary growth backdrop, risk assets tend to perform well. Equities often move higher after the initial rate cut. As the Fed’s actions bolster global liquidity and lower funding costs, EM economies and markets stand to benefit from improved capital flows and reduced external vulnerabilities.

A softer USD

We expect the U.S. dollar to weaken further, which should provide an additional tailwind for emerging market assets. Despite the dollar’s decline in 2025, USD remains about 10% above its fair value on a trade-weighted basis, suggesting scope for further depreciation. Lower U.S. interest rates, a larger U.S. fiscal deficit and improving global growth all point to continued USD downside. A softer dollar tends to support EM currencies, reduce external debt burdens, and improve the competitiveness of EM exports. This currency dynamic, combined with easier global financial conditions, should help sustain positive performance across both equity and fixed income markets.

EM equities: Strong relative performance, upside risks

This past year has offered a preview: 2025 is the first time since 2020 that EM equities have outperformed developed market (DM) equities. As multiples re-rated, the MSCI EM index led the MSCI World Index by 13 percentage points through November 17, 2025. Looking back over the past 20 years, MSCI EM has underperformed MSCI DM since the third quarter of 2010. Since September 30^, 2010, DM equities in USD terms have beaten EM equities in USD terms by around 240%, or just under 8% annually. It is only since November 2024 that we have seen this outperformance reverse.

What is driving this change?

Several factors explain the higher EM P/E ratios and narrowing spreads between DM and EM multiples this year: an improving macroeconomic outlook and structural reforms in some EM countries; a better outlook for some sectors in a number of EM markets; and, finally, a weaker USD and easier financial conditions globally.

If we break down the regional drivers of return and consider the currency impact, we see that China, Korea and Taiwan stocks account for around two thirds of overall EM equity returns – each with its own unique drivers. Meanwhile India, the other major component of the MSCI EM index, contributed little to returns given that its EPS growth was mostly offset by multiple contraction from elevated levels. In aggregate, however, EM multiple expansion, especially in China, dominated the contribution to returns at the index level.

The currency translation component is also meaningful – accounting for around one sixth of the index returns. This makes USD weakening the third largest factor in EM equity performance in 2025 after Chinese and Korean equity market gains.

Further multiple rerating from here seems plausible in relative terms (the spread between DM and EM multiples could continue to narrow). But in absolute terms, EM valuations now look rather full when compared with their own history. Arguably this says more about the extremes of valuation in developed markets than the valuations in emerging markets, but it is unlikely that EM valuations would expand during a period of DM multiple contraction.

Looking forward over the next 12 months and assuming a continued economic expansion during that period, further EM upside will likely come from two sources: improved corporate profits and/or a reduced share count.

The case for EPS upside finds support in a marginally improving economic outlook – particularly in Asia which accounts for over 80% of the index by market cap (Exhibit 1). A key part of the story: a better macro backdrop leads to stronger profit margins. We do not expect to see margins revert to mid-2010s levels in China, but equally we note that China’s policymakers are looking for efficiency in the country’s capital markets. Thus we expect profit margins to stabilize after many years of decline beginning in the second half of the 2010s.

The index sector mix offers another source of support to EM profit margins. As highly profitable technology firms emerge from a period of intense competition and increased regulation, we see scope for index level profit margins to improve as those headwinds abate.

A weaker USD and easier financial conditions globally can also help boost corporate profits. Higher local FX rates relative to USD are a disinflationary impulse domestically for EM nations, in turn allowing easier local financial conditions and improving the outlook for company earnings.

A reduction in net dilution

We turn now to the second source of EM equity upside- the share count. For many years net dilution (increasing share count) has constrained EPS growth. Now that is changing.

If we look at earnings and EPS growth for DM companies over the last 10-15 years, we see that earnings and EPS have grown at roughly the same rate. In other words, index level shareholders have captured almost all of the profit growth. In the DM regions that have been de-equitizing through buybacks (the U.S. for many years and more recently Europe and Japan), EPS returns have gotten an extra boost.

The picture is different in emerging markets. The pace of earnings growth has been more or less in line with developed markets, but EPS growth has barely budged even as EM revenue growth has eclipsed its DM counterparts.

For the last 15 years, net dilution has acted as a 400bps per year headwind to EM EPS. In China investors faced an 820bps per year headwind that effectively wiped out earnings at the EPS level. Chinese company revenues have roughly tripled since 2010, but shareholder dilution (and to a lesser extent margin contraction) eliminated those gains when translated into EPS terms.

Looking ahead, we think net dilution across emerging markets – led by China – could fall to around 150bps a year. The change may be front loaded for a few reasons. First, we expect policymakers to feel a sense of urgency to address market inefficiencies and attract new capital. Second, we note local efforts to improve emerging markets on a sector-by-sector basis, encouraging mergers, acquisitions and consolidation to improve company efficiency.

Third, we note that private equity firms and other financial sponsors are becoming more active in emerging markets and across Asia, which raises the prospect of de-equitization. To be clear, we do not expect de-equitization to take hold, expecting that net dilution will continue to act as a drag on EM equity returns. But a renewed focus on profitability and initiatives that seek to reduce net dilution point to a secular upside risk for EM equity.

Add to that the impact of weaker USD, continued monetary policy easing, and a generally improving outlook in Asia, and EM equity has a reasonable outlook over the longer term. Over  a 1- to 3-year horizon, many of the longer-term themes are likely to be frontloaded which supports the near-term case for the bloc.

Of course, China is key to any EM outlook and here we note the striking turnaround in the Chinese equity index in 2025. Regulatory pressures on the tech sector appear to have stabilized, and given the high concentration of the U.S. tech sector in U.S, equity markets, Chinese tech stocks could potentially benefit from investors looking to further diversify their global equity holdings. Other measures linked to efficiency in the corporate sector and “anti-involution” initiatives to reduce unhealthy competition also present the potential for more stable profit margins and a more robust outlook for Chinese companies.

In sum, we see upside risks and the beginning of renewed international investor interest in Chinese equities.

EM debt: Compelling yields

Turning to emerging market debt (EMD), we continue to overweight the asset class, given improving fundamentals, attractive relative valuations, and solid technicals. Spreads have partially retraced their upward move and currently sit at around 270 bps, with EMD high yield spreads at 470 bps and investment grade at around 95 bps. Yields are compelling, with EMD yield-to-worst close to 7.0%.

 The EMD outlook is further bolstered by U.S. consumer strength, China’s policy stimulus, and the potential for further weaking in the dollar. Issuance is strong and flows have turned positive, with upgrades outpacing downgrades. Historically, EMD high yield has been a top performer during periods of non-recessionary Fed easing.

Here is a snapshot of our asset class views: 

5a50357b-837a-11f0-9fe1-45b9bb49a9d4