Emerging Markets Crushed US Stocks In 2025: Can It Last?

Key Concepts

Emerging Markets (EM) Stocks Rally
MCSI Emerging Markets Index
S&P 500
US Dollar Weakening
Federal Reserve (Fed) Rate Cuts
Emerging Market Central Bank Rate Cuts
Valuations (Forward Price-to-Earnings Ratio)
Risk Appetite
Soft Landing
AI Boom (Hard Tech vs. Soft Tech)
Corporate Governance Reforms
Nearshoring
Geopolitical Risks
China Property Market Fragility
Dispersion in EM Performance
Free Trade (Investment Platform)

Emerging Markets Stocks: A Resurgence

Emerging market (EM) stocks are experiencing a significant rally, outperforming developed markets. The MCSI Emerging Markets Index is up approximately 25% year-to-date, surpassing the S&P 500's 16% gain. This marks the strongest EM performance since 2017, prompting an examination of the driving forces behind this turnaround.

Drivers of the EM Rally

Several key factors are contributing to the current EM resurgence:

US Dollar Weakening: A 10% drop in the US dollar since January has been the primary catalyst. A weaker dollar:
- Reduces the burden of servicing EM debt.
- Increases local purchasing power within EM countries.
- Attracts capital into higher-yielding EM assets. Historically, EM equities tend to outperform during periods of dollar depreciation.
Federal Reserve Pivot and Easing Financial Conditions: After two years of monetary tightening, the US Federal Reserve pivoted in September 2024, initiating rate cuts. This easing of global financial conditions has provided EM central banks with the flexibility to cut their own rates. Countries like Mexico, South Africa, India, and China are already well into their rate-cutting cycles. This cheaper credit is stimulating investment and consumer demand across the developing world.
Attractive Valuations: Despite the recent rally, EM equities, in aggregate, trade at a forward price-to-earnings (P/E) ratio of just 14 times, with an expected profit growth of nearly 12%. This contrasts sharply with the S&P 500, which trades at 24 times earnings with similar growth expectations. This suggests that EM stocks offer greater value for invested capital. Data indicates that the US market is priced significantly higher than other countries. However, it's noted that not all EM markets are equally cheap; India, for instance, is only slightly less expensive than the US.
Increased Risk Appetite: In the later stages of a market cycle, as investors gain confidence in a "soft landing" scenario, there's a tendency to seek higher yields and chase performance. This environment often benefits EM equities. As market volatility decreases, global capital shifts from safer regions like the US to higher beta regions such as China, Brazil, South Korea, and Indonesia. EM equities and currencies typically perform best when investors believe the worst is over, even if fundamental improvements are not yet fully realized. Therefore, the 2025 EM rally is attributed to both improved data and a renewed optimism driven by the global search for returns.

Impact of Trade Truce and AI Boom

US-China Trade Truce: An October trade truce between the US and China, which included China lifting export controls on rare earths and the US easing some tariffs, provided relief for Asian and Latin American exporters.
AI Boom Expansion: The artificial intelligence (AI) boom has expanded beyond "hard tech" (e.g., chips, hardware) to "soft tech" (e.g., software, internet platforms, IT services). This has benefited Chinese and Korean tech firms, with companies like TSMC and Samsung reporting double-digit profit growth this year due to their central role in global AI infrastructure.

Leading Countries in the Rally

Several countries are spearheading the EM rally:

South Korea: The Korean Cosby index has surged over 50% year-to-date, driven by corporate governance reforms and the AI semiconductor boom. The market's heavy concentration in semiconductor companies like Samsung and SK Hynix, which are crucial for AI infrastructure, has amplified gains. Foreign investors have poured $11 billion into Korean stocks between May and September.
Taiwan: The Taiwanese market's performance is largely attributed to TSMC, a key player in the AI revolution, with profits up nearly 40%.
Brazil: After a weak 2024, Brazil has seen a strong rebound. The Brazilian Real has strengthened, interest rates are falling, and valuations remain attractive at under nine times forward earnings. The stock market has surged over 40% in dollar terms, supported by strong domestic fundamentals (fiscal reforms, easing inflation, consumer demand rebound) and global tailwinds (weaker dollar, expected rate cuts). Domestically focused sectors like finance, retail, and construction have led the rally.
Mexico: Mexico is benefiting from its "nearshoring" advantage, with companies relocating supply chains closer to the US. The equity market has returned double that of the US, and the Mexican Peso is one of the world's strongest currencies. Significant foreign investment in nearshoring has boosted industrial real estate and manufacturing. Defensive sectors like staples and telecoms have also contributed to returns. Rate cuts, a weaker dollar, and cheap valuations further enhance Mexico's appeal.

Will the Rally Last?

The case for continued EM strength appears solid, but with caveats:

Positives:

The US dollar may continue to weaken as the Fed maintains its rate-cutting cycle.
EMs trade at a 30-40% discount compared to developed markets.
Earnings forecasts for EMs are being revised upwards.
Long-term mega-trends such as favorable demographics, supply chain shifts, clean energy, and tech adoption favor EM economies.

Risks and Caveats:

China's Property Market: Remains fragile.
Geopolitics: Potential for renewed geopolitical flare-ups.
Valuation Concerns: Markets like India and Taiwan may now be expensive after their strong performance.
Dispersion: Expect greater divergence in performance. Countries with strong domestic stories (e.g., Brazil, Mexico) may continue to outperform, while those heavily reliant on the AI infrastructure boom could falter if that narrative weakens.
Concentration Risk: The rally in Taiwan and South Korea is heavily influenced by a few key companies (TSMC, Samsung, SK Hynix). Similarly, in Hong Kong, companies like Alibaba, Xiaomi, and Bilibili, expected to benefit from the AI boom, have driven gains.
EM Volatility: Emerging markets are inherently higher risk and can experience rapid crises. Investors are cautioned against simply chasing performance and advised to ensure growth is real, valuations are reasonable, and currencies have room to strengthen.

Conclusion and Investment Guidance

Emerging markets are indeed back, but investors should exercise caution and avoid blindly chasing performance. It is crucial to identify genuine growth drivers, assess reasonable valuations, and consider currency potential. As a guideline, a market-cap weighted global equity fund typically allocates around 10% to emerging markets. Investors are advised to keep their EM tilts reasonable and be prepared for potential disappointment, as EM investing is not a smooth ride.

Free Trade Investment Platform Promotion

The video is sponsored by Free Trade, a commission-free investment platform.

Pension Transfer Offer: 2% cashback on pension transfers of £10,000 or more, capped at £1,000 per customer. Offer ends December 31, 2025.
ISA Offer: 1% cashback on transfers of £10,000 or more for new ISA customers, capped at £1,000. Offer ends December 31, 2025. Free Trade emphasizes simplicity, transparent pricing, and a free ISA. They have won "Best Online Trading Platform" at the British Bank Awards for six consecutive years and have over 700,000 customers. Details can be found at freetrade.io/pensioncraft or via the link in the description.