October 2025*
Emerging Markets (EM) have outperformed global equities this year, and we expect the conditions for this strength to continue into 2026. Key drivers include a weaker US dollar, sustained AI-related investment, and China’s rebound from multi-year lows. Valuations remain attractive, with EM equities potentially breaking out of a decades-long range. We favour exposure to AI hardware (Taiwan, South Korea), supply-chain realignment beneficiaries (Mexico, Vietnam), and energy-transition plays (Chile), while maintaining exposure to China A-shares. This quarter, we downgraded Indonesia.
Emerging Markets (EM) have outperformed global equities (ACWI) year-to-date, and our indicators suggest this trend can persist going into next year. For several years, the common narrative for EM equities has been a cheap market, but a positive catalyst was elusive amid USD strength, US big-tech dominance (e.g. FAANGS and Mag-7), and China’s slowdown. Some of these trends may persist; however, EM tailwinds are becoming more evident. Additionally, the MSCI EM Index also appears to be breaking out of a multi-decade range (see chart 1), while EM equities remain attractively valued (see chart 2). The three main catalysts supporting EM strength are 1) a weaker dollar, 2) AI growth, and 3) Chinese stocks recovering from 2024 lows.
The US dollar index (USTWBGD Index) is down 6.6% year-to-date. The downtrend has flattened in recent months, but we remain dollar bearish over the next six to 12 months as outlined in our Special Report US Dollar Weakness: A Crowded Idea, Uncrowded Trade (July 2025). Long term, we expect the greenback’s rich valuation and some moderation in financial inflows into the US to weigh on the world’s reserve currency. Currently, a dovish Fed is an important cyclical driver of USD depreciation (see chart 3). Historically, EM equities outperform in weaker USD environments.
Artificial Intelligence (AI) remains an important structural driver for EM. This year, IT became the largest sector in the MSCI EM Index (24.6% as of August 2025), overtaking Financials (23.4%). If US hyperscaler capex continues to expand (see chart 4), EM’s large tech and AI-related hardware exposure will likely continue to benefit. The market debate is currently centred on the sustainability of large and growing AI-related capex. This publication does not focus on the future profitability of company-specific stocks. However, we expect US big tech capex expenditures to continue to support robust demand for advanced chips and hardware. Defending or disrupting existing ‘moats’ incentivises Mag-7 firms to continue spending. Also, US-China geopolitical competition provides a powerful incentive for sovereigns to supplement corporate spending. The US government’s 10% stake in Intel is one example of growing state intervention, which is starting to resemble China’s industrial policy investment in AI.
The MSCI China Index total return was 44% this year (in USD terms), supporting the overall EM index rebound. China is the largest country weight in EM, which was a material drag on overall EM performance over 2021-23. Since late 2024, Chinese stocks have rebounded, becoming one of the best performing countries over the past year. Supportive factors more recently include a China tech re-rating, anti-involution policies, looser monetary policy, and growing speculation of a US-China trade deal. There is still scope for disappointment on some of these fronts. However, the case for owning China has become stronger. Recent momentum may also draw in more participation from foreign investors or domestic households. Chinese households have accumulated excess savings since 2018, and their equity allocations are low, at around 10% (versus 10-15% historically).
| 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 30th September 2025, and macro events and data releases up to 3rd October 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.