EM optimism after stellar year

EMERGING markets (EMs) are poised to start 2026 as a favoured trade on Wall Street, with money managers betting a multi-year cycle of investment inflows is underway.

This year’s capital rush into the sector – the best since 2009 across all EM securities – is a sign more investors are allocating to a sector that’s been out of favour after years of lacklustre performance.

For the first time since 2017, emerging stocks are outperforming US peers, the gap between its bond yields and those of US Treasuries have shrunk to the lowest in 11 years and carry trade strategies – which largely consist of borrowing in a lower-yielding asset to fund purchases in higher-yielding ones – have reaped the best profits since 2009.

Enthusiasm for the sector was on full view at Bank of America Corp’s (BofA) recent investment conference in London. The bank hosted 300 investors and found scant pessimism on EMs.

The verdict from David Hauner, BofA’s head of emerging fixed income: “EM bears have gone extinct.”

What may be underway is a more fundamental shift in global investment flows.

Portfolio managers are keen to diversify from the United States, while also increasingly drawn by developing nations’ progress in cutting debt and taming inflation.

It’s a turnaround few saw coming. Until recently, investors were avoiding the asset class after years of weak returns and fearful of a US trade war.

Money managers found it tough pitching it to clients, while hedge funds said they saw the best opportunities in betting against EMs.

“2025 was an inflection point,” says Sammy Suzuki, head of EM equities at AllianceBernstein LP in New York. “The question a year ago was whether EMs were even investable, but that’s no longer a query we receive.”

The market remained upbeat on Monday, with the MSCI EM stock index rising 1%, extending its gains for the year to 28.5%.

More upside

Banks such as JPMorgan Chase & Co and Morgan Stanley have joined the bullish chorus, predicting EMs will benefit from dollar weakness and the investment explosion in artificial intelligence.

JPMorgan projects as much as US$50bil of inflows into emerging-debt funds next year.

“One of our best ideas is still to hang with local EMt debt,” says Bob Michele, global head of fixed income at JPMorgan Asset Management Inc (JPMAM).

“We should get a little price appreciation, we should collect carry, and we think EM foreign exchange has a little bit more upside.”

Morgan Stanley too advises clients to hold local-currency bonds, and to buy more dollar-denominated emerging debt.

BofA expects hard-currency emerging bonds to repeat this year’s double-digit returns.

A key driver could be positioning; despite the rally, investment flows are relatively small so far.

US ETFs focused on EM stocks absorbed almost US$31bil in 2025, Strategas Securities estimates.

Emerging debt funds have taken in over US$60bil, according to EPFR Global data compiled by BofA, yet that follows outflows of US$142bil in the previous three years.

That means EMs remain under-represented in global portfolios.

The year marked “the return of asset allocators after a brutal five-year stretch,” says Todd Sohn, senior ETF and technical strategist at Strategas in New York. “Many realised they were overexposed to US large-cap growth equities and moved to globally diversify.”

Meanwhile, EMs’ share of global stock and bond benchmarks is on the rise. Equities added more than one percentage point of weight versus developed markets to approach 13% in the Bloomberg World Large & Mid Cap Index, while emerging debt also gained share in the Bloomberg Global Aggregate Total Return Index.

Rajeev De Mello at Gama Asset Management SA says investors are finally re-engaging with EMs, but sees scope for them “to move towards a more meaningful overweight.”

Dollar question

This year’s rebound may be obscuring vulnerabilities in the asset class. China, stuck in a deflationary cycle, could pose a challenge as it exports excess capacity into other developing countries, heaping pressure on local industries.

But the biggest test lies in the dollar. Its 8% slide this year helped buoy emerging assets, but many reckon it could rebound should the US Federal Reserve (Fed) deliver fewer interest rates than expected.

Citigroup Inc strategists for instance advise clients to buy only emerging assets that can withstand a potential greenback bounce. Despite that, the bank expects 5% total returns from emerging bonds next year.

JPMAM’s Michele too is sticking with bullish emerging-debt positions; he expects “very high” real yields to continue drawing investors even in a stronger-dollar scenario.

For now, cash is pouring in – emerging-debt funds absorbed US$4bil in the week to Dec 17, the biggest weekly flow since July. And should EMs withstand dollar and Fed policy shifts, cautious investors may become convinced a structural re-allocation is indeed afoot, according to Suzuki of AllianceBernstein.

“This uncertainty provides investors with a window of opportunity to jump in,” he says. “Once everyone believes in it, it might be too late.” — Bloomberg