Even if the Federal Reserve pauses its rate cuts today, as widely expected, this is unlikely to slow the emerging markets rally we have seen across equities and bonds over the past year or more.
The inextricable relationship between the direction of US monetary policy and emerging market risk assets remains powerful, but this time the rally is not just about the Fed.
Over the past 18 months many emerging economies have moved earlier and more decisively than the US in tackling inflation, leaving real policy rates positive, external balances healthier and fiscal trajectories more stable than in several large developed markets.
At the same time, earnings revisions have turned more favourable for a number of key emerging market sectors, particularly in Asia, where companies are central to the buildout of artificial intelligence (AI) related hardware and digital infrastructure.
This is therefore a story of strengthening economic fundamentals, a widening growth differential and a more supportive domestic policy backdrop, turning emerging markets, in our view, from a tactical allocation into a more central component of the next phase of market broadening.
Overweight on emerging markets
For many of these reasons, we were already constructive on emerging markets. As of this quarter, we are more bullish, complementing longer-standing overweights on emerging market bonds and currencies.
Importantly, this upgrade largely reflects India being raised to overweight from underweight – underpinned by lower valuations, improving macro momentum and potential for foreign inflows – and Brazil’s elevation to overweight from at target, supported by monetary easing and commodities demand, a factor also benefiting other resource-rich emerging economies. This brings these two markets in line with the overweight we have had on China since last year.
Crucially, our constructive stance on emerging markets is not confined to these three markets, nor is it purely a valuation or policy call. We see a broader opportunity set developing across emerging economies, particularly in Asia, where reforms, improving corporate governance and rising participation in the AI and digital infrastructure value chain are reinforcing the macro story and benefiting key markets.
Korea’s equity market has been a clear example. The KOSPI index hit fresh record highs last week, supported by foreign buying concentrated in AI semiconductor companies.
Leadership extends beyond a few index heavyweights to high-bandwidth memory suppliers and semiconductor equipment makers, as investors focus on the full AI supply chain. Our research points to Korea as one of the next major hubs for AI-related investment, supported by trends in patent filings and capital spending.
Cross-asset diversification
This highlights how emerging markets can provide a compelling complement to, and source of diversification from, US mega-cap technology stocks, which, despite delivering exceptional returns, leave investors heavily exposed to a narrow set of business models, regulatory regimes and valuation assumptions.
Emerging markets, by contrast, offer a different mix, including a greater representation of cyclical sectors such as financials, materials and industrials, which are linked to domestic development and global trade rather than only to digital platforms.
Many emerging economies also provide exposure to structural themes like demographics and urbanisation, which are largely absent in developed markets.
The case for broadening into emerging markets is not just an equity story, either. Emerging market sovereign and corporate debt have evolved from a niche, high-beta segment into a deep, differentiated opportunity set.
Recent performance across emerging markets rates and credit has been robust, in many instances outperforming developed market equivalents, reflecting a combination of higher starting yields, earlier policy adjustment and improving fundamentals.
This has been reinforced by a more supportive external backdrop – including a softer US dollar and stabilising global growth – as well as, in many cases, more contained debt burdens and default rates than in developed markets, enabling the capture of higher yields without a proportional deterioration in credit quality.
Moving to a core allocation
In our view, emerging markets now offer: a macro growth premium at a time when developed market growth is only slowly reaccelerating from a lower base; a way to broaden equity exposure beyond US mega-cap concentration into cyclical, domestic demand and AI infrastructure themes; and access to a more mature, diversified emerging market debt universe where fundamentals have, in many cases, improved relative to developed peers.
Emerging markets also stand as a potential beneficiary of Fed easing and a softer dollar rather than a casualty of tightening.
The challenge, then, is not the lack of opportunity, but the need for selectivity: distinguishing between countries and companies that are genuinely reforming, innovating and strengthening governance and those that are not.
For investors willing to look beyond familiar US names, emerging markets increasingly look less like a tactical allocation and more like a central pillar of a broader, more resilient global allocation.
Shannon Saccocia is chief investment officer of wealth at Neuberger Berman. The views expressed above should not be taken as investment advice.