RBC Bluebay AM: Emerging markets return to favour
Laurence Bensafi, Deputy Head of EM Equities, discusses what’s driven the outperformance of the asset class in the year-to-date and considers whether this trend has further to run.
Key takeaways
- Emerging market equities are the top performers so far in 2025, boosted by a weaker US dollar and investors looking for alternative growth areas to the US.
- China, India, and Saudi Arabia are challenging the ‘superpower’ status of the US.
- EM stocks are trading near a historical discount to DM equities, despite their superior growth prospects.
Emerging market (EM) stocks have lagged their developed market (DM) counterparts since 2011, reversing their outperformance over the first decade of this century. The dollar’s strength over this period was a headwind for EM equities, while slowing EM earnings growth relative to many DM countries, particularly US tech stocks, was also a factor. However, 2025 has seen a turnaround, with the MSCI EM Index outperforming other regional equity indices over the first six months of the year.
Trump was the turning point
It is perhaps surprising to look back at late 2024 forecasts and see that Donald Trump’s presidential re-election was anticipated to prolong the period of US exceptionalism. His business-friendly agenda was expected to be positive for the US economy and company earnings. Instead, his presidency has highlighted some of the weakness in the US economy.
President Trump’s proposed reciprocal tariffs and the subsequent trade negotiations have shown that the US’s bargaining position may not be as strong as he had hoped. The world has changed and other superpowers, such as China, India and Saudi Arabia, are rising to the fore. China, in particular, held its nerve during a series of tit-for-tat tariff hikes, sounding cool upon entering trade talks as it realised it could likely hurt the US more than the US could hurt China – especially when it comes to the supply of rare earth minerals so essential to the US tech supply chain.
Another Trump-related issue has been his ‘Big, Beautiful Bill’ which is expected to add at least USD3 trillion to the US budget deficit over the next decade[1]. Higher government borrowing means increased Treasury issuance. Historically, EM countries, such as China, have been willing buyers of US Treasuries, but this is changing: these countries are increasingly aware that there are other ways of responding to higher US tariffs without resorting to a trade war.
It’s all about the dollar
The dollar has been on a downward trend since US interest rates peaked in October 2023, but the deceleration has picked up pace since Trump returned to the White House. Recessionary fears, the US president’s repeated attacks on Federal Reserve Chairman Jay Powell’s refusal to slash interest rates, concerns over the size of the US budget deficit, and policy stability have all conspired to weaken the greenback.
While there is a general recognition that Trump’s policies require a weaker dollar to succeed, the speed of that depreciation is key. A gradual depreciation over the next few years would make US exports more competitive and persuade EM countries to import more from the US, helping to rebalance the global economy. So far this year, the US Dollar Index, a measure of the dollar’s value against a basket of its major trading partners, has fallen around 10%.
EM countries offer high-quality growth opportunities
Uncertainty in the US has sparked interest in growth opportunities in other areas of the world. EM stocks, along with those in Europe, have been an area of focus. As well as future population growth, EM countries offer the largest opportunities for productivity gain and economic growth, as well as high-quality companies that can capture those opportunities and turn them into earnings growth.
Yet, despite these favourable trends, EM stocks trade at a historically high discount of around 50% to US equities, as shown in the chart below. This compares to a 10% premium back in 2011.
While we aren’t expecting a premium to return in the near future, we would estimate that fair value would be in the region of a 20% discount, given the amount of geopolitical uncertainty in the world at present. That still leaves significant upside potential for EM equities relative to US stocks.
[1] Committee for a Responsible Federal Budget forecast.