Outlook 2026: After a strong run, can a bull case still be made for EM equities in 2026?
Tom Wilson explores the factors that could sustain emerging market equity performance in 2026.
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Emerging market (EM) equities have performed strongly in 2025, outperforming global equities. After more than a decade of underperformance, are we at an inflection point and to what extent can EM equities continue to deliver good US dollar returns in 2026?
Emerging markets are not homogenous, so it helps to look at EM with regard to its constituent parts. Four countries make up 80% of the MSCI EM equities benchmark: China, India, Taiwan and Korea.
China faces ongoing structural and cyclical economic headwinds: investment remains too high a share of gross domestic product (GDP), debt levels are elevated, the economy suffers excess capacity and persistent deflation and appears to be in a liquidity trap. A real estate bust has materially damaged local government finances and continues to suppress household confidence. However, China is highly innovative and competitive, which combined with ongoing improvements in product quality, is enabling both import substitution and an ongoing increase in export market share. Its equity market is very broad, and we can find multiple idiosyncratic stock opportunities. Furthermore, in the near term, abundant liquidity is proving a stronger driver of share prices than nominal growth. Geopolitical tension will continue, but China’s dominance in rare earth processing and magnets has proven a key point of leverage that defends China against excessive US tariff and non-tariff action. Valuations have lifted, having been cheap 12 months ago, but are reasonable, and we remain constructive on China.
India has delivered soft US-dollar returns in 2025 and has materially underperformed after a long period of outperformance. Equity valuations have improved but while financials valuations are attractive, non-financials valuations remain expensive. Equity supply has been a significant offset to domestic fund flows in 2024 and 2025, and other parts of emerging markets have offered better valuations and similar or better earnings growth. However, relative performance may at some point inflect. The narrative of structural growth is well recognised. On a shorter horizon, low inflation and a soft dollar have facilitated monetary easing, and we have also seen some modest fiscal easing. This should support a recovery in nominal growth from relatively low levels. A further catalyst may come in the form of tariff relief as the US tariff premium on India’s import of Russian crude may at some point be removed, even if there is ongoing risk around India’s service exports to the US. Finally, if the AI theme rolls over, India would likely benefit from a redirection in flow.
This brings us to Taiwan and Korea. Taiwan’s benchmark is currently 85% technology, Korea is 50% technology. AI hardware spend has been a powerful performance driver in 2025. While management commentary, positive earnings dynamics and a further material increase in capex guidance have strengthened our conviction that AI-related tech demand will remain robust into 2026, there is uncertainty on capex in 2027. There are outstanding questions on the timing of AI monetisation, the dilution of hyperscaler returns and potential power constraints. At this time, information technology warrants an overweight, given its strong earnings momentum, but valuations have risen, and investors should be disciplined in trimming tech companies that run ahead of fundamentals.
Finding opportunities beyond the big four
Given their scale, the above four markets dominate EM beta. However, for active investors, there remain plenty of alpha opportunities in the universe. We think favourable conditions warrant an overweight allocation to Brazil. Equity valuations are attractive, the real effective exchange rate is cheap, and real interest rates are very high. Elections in Brazil in October 2026 may see President Luiz Inácio Lula da Silva lose to a centre-right candidate. A more fiscally responsible centre-right government would calm fears about fiscal sustainability and drive a material compression in real rates. This would reduce the cost of capital, drive a marked rerating, support the currency and drive an uplift in domestic equity allocations from low levels. While this is partly anticipated by markets, we believe the risk/reward lies in favour of investors. Meanwhile, low inflation will permit a degree of monetary easing in 2026, and Federal Reserve easing and a soft dollar would provide additional support.
Figure 2: US dollar real effective exchange rate and EM equites relative performance
Source: Bloomberg, Schroders, Macrobond, BEA. Latest data as at Oct 2025. Current performance trends are not a guide to future results and may not continue.
This leads us to talk about the US dollar and longer-term trends. We are inclined to anticipate US dollar depreciation on a structural basis, given its rich valuation, a diminished appetite for foreign funding of US deficits and longer-term potential for fiscal monetisation. US dollar depreciation would provide a tailwind to EM relative equity performance as it eases financial conditions and has a positive translation effect, benefitting dollar-nominal growth and earnings. The chart in figure 2 shows the historic inverse correlation between the US dollar and EM equities relative returns. This may combine with attractive relative valuations, and a potential stabilisation or improvement in relative return on equity (ROE). This is the bull case for EM but, as ever, the outlook is uncertain. Meanwhile, key risks include a rollover of the AI thematic, geopolitical tension and policy volatility. However, whatever the challenges, we believe EM equities continue to offer value and that investors can benefit from the diversification benefits and active investment opportunities that this market provides.
Learn more about investing in the Schroder Global Emerging Markets Fund.
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