As an asset class, EM equities have proved resilient to this year’s geopolitical tremors. But the highs and lows stress the need to be selective.
Whilst it was a strong start to the year for emerging market (EM) equities, robust headline performance tells only part of the story. Markets have been characterised by significant dispersion, with the conflict in the Middle East driving elevated volatility, rising geopolitical uncertainty, and concerns around higher oil prices. We expect this more uncertain and differentiated market backdrop to persist for the remainder of the year.
Despite this, we believe the outlook for EM equities is persuasive. Firstly, they’ve appeared relatively resilient in the face of geopolitical uncertainty. Although higher oil prices may be a problem for oil importing countries like India, central banks have been much more orthodox in this cycle, meaning policy rates are high and inflation is running well within target bands across much of the region. As a result, elevated oil prices are unlikely to materially alter the path of monetary policy in EM, with scope for further rate cuts in some countries.
The fiscal backdrop is also relatively robust, with cleaner budget balances than in previous cycles. EMs have less dollar-denominated debt than in the past, making them less exposed to geopolitical risks. Taken together, this supports the case for EM as a diversification source versus developed markets, where fiscal conditions are becoming more strained.
Investors shouldn’t just think of emerging markets simply as a source of diversification.
There are several structural growth drivers creating opportunities across the investment universe making EM an attractive portfolio allocation in its own right.
Take the AI supply chain. High-quality tech hardware businesses in Taiwan, for example, are benefitting from hyperscalers’ AI capital expenditure (capex). This provides a good way to access the AI theme without the elevated multiples seen in parts of the US. We also remain constructive on memory, given the attractive supply-demand backdrop, underpinned by tight capacity and growing demand for AI servers.
Elsewhere, commodities look attractive over the rest of the year. We like copper, where accelerating grid investment is driving demand as supply tightens. There’s significant value among gold miners, with many producers trading on double digit free cash flow yields at current spot prices and below. Strong commodity prices also support exporters, particularly in certain Latin American markets and South Africa.
Some EMs look well placed to benefit from the evolving geopolitical landscape over the medium term. Mexico, for example, is likely to benefit from nearshoring, as US businesses continue to move parts of their supply chains closer to home.
Shifts like this combined with periods of elevated volatility can provide rich hunting grounds for active stock pickers with a longer-term investment horizon. Broad de-ratings provide a chance to add exposure to high-conviction names at more attractive multiples. Taiwan’s tech sell-off in March was just one such example.
There are, of course, pockets of weakness. EM continues to be highly dispersed, with attractive opportunities for commodity names with AI supply chain exposure, but with several problem sectors too, such as Indian IT services or Chinese housing. With this differentiated backdrop likely to persist through the rest of 2026, investors should look for the resilient structural growth stories and be wary of where pressures are unlikely to ease.
