January 2026*
Emerging Markets (EM) delivered strong performance in 2025, and we expect supportive conditions to persist into 2026. Key drivers include a softer US dollar, sustained AI-related investment, and improving earnings momentum across the EM technology sector. Valuations remain attractive relative to developed markets. We continue to favour exposure to AI hardware (South Korea, Taiwan), supply-chain realignment beneficiaries (Mexico, Vietnam), and energy-transition plays (Chile), while maintaining selective exposure to China A-shares. This quarter, we upgraded the UAE to a small overweight.
2025 marked a strong year for Emerging Market (EM) equities, gaining 34% and outperforming the All Country World Index (ACWI) by 11 percentage points. Several macro drivers aligned well for EM equities – including USD weakness, Artificial Intelligence (AI) growth, and improving China sentiment – allowing most major markets to produce positive returns. However, chart 1 highlights key divergences within the EM benchmark. South Korea was the strongest market, supported by robust demand for memory chips. Taiwan also outperformed due to its semiconductor exposure. China marginally underperformed the benchmark, while India was a laggard.
Our main views are unchanged for 2026. AI remains a core theme. The debate surrounding the sustainability of US hyperscaler capex may persist, but we expect spending to continue rising over the coming quarters. The MSCI EM Index’s large technology exposure is a tailwind, supporting the HATTS** (see chart 2) and the broader manufacturing supply chain. Our highest-conviction overweight remains South Korea. Demand for high-bandwidth memory (HBM) and legacy memory is likely to continue outpacing supply in 2026, and Korean memory exporter contract pricing is expected to continue rising (see chart 3).
The US dollar index (BBDXY Index) depreciated 8% in 2025 but traded flat in the second half of the year (see chart 4). If the Fed maintains a dovish stance, we expect rate differentials to drive further USD weakness in 2026. This is one factor underpinning our positive EM equity view and helps guide country allocation. Chart 5 shows that Gulf Cooperation Council (GCC) countries tend to underperform during USD bear markets. By contrast, South Korea should see some easing in local currency outflows, while China should be able to pursue easier monetary conditions as RMB pressures ease.
Stability in China remains an important factor for EM outperformance in 2026. The MSCI China Index slightly underperformed the MSCI EM Index in 2025 as US–China relations stabilised and Chinese earnings delivered modest single-digit growth. This backdrop allowed EM headline earnings growth to outpace DM, led by higher-growth markets such as South Korea and Taiwan. We expect these trends to persist, although China may surprise markets, as seen in September 2024 and January 2025. China’s tech giants could have another “DeepSeek moment” in the AI race, further supporting the domestic AI ecosystem. In addition, large household savings could shift back into domestic equities if policymakers successfully lift domestic confidence (see chart 6). We continue to favour exposure to China A-shares.
The US midterms are an important event for policy. The slim Republican majority in Congress may limit scope for a new fiscal package. However, the Trump administration already appears to be attempting to influence both the energy market and the Fed. US tariff rates could also fall to help stimulate growth and reduce inflation – both important factors for the upcoming election. Our preferred friend-shoring allocations remain Mexico and Vietnam.
Crude prices trended lower in 2025, driven by a net oil supply surplus (see chart 7). The US EIA projects another surplus in 2026. The recent US intervention in Venezuela is unlikely to materially affect oil supply in the short term – Venezuela currently only accounts for around 1% of global production – but longer-term implications may be more significant. Venezuela holds the world’s largest proven oil reserves, and US firms could regain access to increase production. This represents an upside risk to future supply and potentially adds downward pressure to global oil prices.
| Chg | -2 | -1 | 0 | +1 | +2 | |
|---|---|---|---|---|---|---|
| Asia | ||||||
| China† | – | |||||
| South Korea | – | |||||
| Taiwan | – | |||||
| Malaysia | – | |||||
| Indonesia | – | |||||
| Philippines | – | |||||
| Thailand | – | |||||
| Vietnam | – | |||||
| India | – | |||||
| Latin America | ||||||
| Brazil | – | |||||
| Mexico | – | |||||
| Europe, Middle East and Africa | ||||||
| Turkey | – | |||||
| Saudi Arabia | – | |||||
| South Africa | – | |||||
| UAE | ↑ | |||||
Note: Up/down arrows indicate a positive/negative change in our asset allocation compared to the previous quarterly outlook. A dash indicates no change. The table shows the major Emerging Markets.
†Allocation is overweight China (via OW A-shares and N offshore stocks).
Source: CLIM
*The publication reflects asset performance up to 31st December 2025, and macro events and data releases up to 8th January 2026, unless indicated otherwise.
The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.