July 2025*
The current US administration is renewing a high-stakes game in global trade, with tariff rates expected to rise following the 90-day post-Liberation-Day pause. This is likely to produce relative winners and losers across Emerging Markets (EM). Meanwhile, broader macro themes – including dollar weakness, advances in Artificial Intelligence (AI), and geopolitical shifts – remain key drivers of EM performance. We expect South Korean equities to continue outperforming, supported by momentum in corporate governance reforms and robust demand for AI-related hardware. This quarter, our allocation adjustments include upgrading India and Argentina to neutral, and downgrading Vietnam to a smaller overweight and Saudi Arabia to underweight.
Emerging Market equities have outperformed global equities (ACWI) year-to-date. Trade negotiations continue to introduce volatility and uncertainty; however, we expect EM to maintain positive momentum as markets refocus on longer-term drivers. Three key factors for EM are the weaker USD trend, growth in AI, and investor diversification into non-US markets.
The US dollar remains the world’s reserve currency but appears increasingly less exceptional. The trade-weighted dollar (Bloomberg DXY Index) has depreciated by 9% this year, and the US real broad effective exchange rate (REER) is still 14% above its long-term average (Chart 1). The short-term outlook for the dollar is difficult to predict, but our one-to-three-year view is negative. In addition to the President Trump’s preference for a weaker currency, cyclical and structural forces are expected to maintain downward pressure on the greenback. The unpredictable policy environment in Washington also contributes to a discount. Furthermore, a narrower current account deficit will reduce US capital inflows. As the dollar’s weaker trend becomes more entrenched, investors, FX reserve managers, and corporate hedgers have a stronger incentive to diversify away from the richly valued dollar. Historically, EM equities outperform in weaker USD environments.
AI continues to grow, both through large language model (LLM) development and capital expenditure on advanced hardware. China’s DeepSeek release in January showed that China is a significant player in the LLM space, capable of competing with US tech giants. In hardware, US hyperscalers’ capex continues to rise (2025 guidance from Meta, Alphabet, Amazon, and Microsoft is currently $327bn), supporting demand for Taiwanese and South Korean semiconductor and memory exports. Some sceptics argue this capex growth is unsustainable. We are agnostic about how US firms allocate R&D to maximize profits. However, the geopolitical rivalry between the US and China suggests an AI race will continue supporting chip orders. Sovereign AI demand is becoming a key factor. For example, the UAE recently agreed to purchase 500,000 Nvidia chips to build data centres. South Korea remains our preferred overweight given its exposure to tech hardware and AI. Additionally, its Value-Up initiatives further support the MSCI Korea index, which still trades at a discount to the EM benchmark (Chart 2).
Valuations are typically cited in support of EM equities. Since 2011, US equities have outperformed EM and other non-US stocks, leading to some fatigue around this argument. In our view, the US market still deserves a valuation premium due to factors such as stronger earnings growth. This is reflected in the MSCI US Index’s roughly 10x forward P/E premium over EM. Nonetheless, the size of this gap leaves little room for US earnings disappointments or positive EM surprises, reinforcing the case for diversification into EM assets.
| 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 30 June 2025, and macro events and data releases up to 9 July 2025, 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.