The end of the equity rally for emerging markets?

• Jean-Christophe Rochat
  CIO
  Banque Heritage

The conflict in the Middle East has abruptly reshuffled the outlook for the global economy and financial markets. Emerging economies are not immune to this shift in the macro-financial landscape. Several transmission channels are at work: imported inflation through a potential rise in hydrocarbon prices, heightened uncertainty and higher risk premia, a possible delay in the Federal Reserve’s rate-cutting cycle, rapid adjustments in capital flows, particularly those linked to carry trade strategies, and a growing dispersion of performance across countries and sectors. Sources of concern certainly exist. But should the emerging markets investment theme be called into question?

Strengthened macroeconomic fundamentals

Since 2023, emerging economies have demonstrated greater resilience. The weakening of the US dollar has reduced their external vulnerabilities, particularly those related to foreign-currency debt, while supporting their local currencies.

At the same time, inflation has normalized. Real interest rates have stabilized at levels often higher than those observed in developed economies, strengthening the relative attractiveness of their financial markets.

As across global financial markets, selectivity is becoming increasingly decisive.

The fragmented geopolitical environment is also accelerating a structural trend toward closer economic and financial ties among emerging economies, often described as the gradual rise of the “Global South.” Despite their recent outperformance, emerging market assets still trade at valuation discounts of around 30 to 40 percent compared with developed markets. Earnings growth prospects remain solid, with consensus forecasts pointing to around 18 percent in 2026. Investment inflows also remain broadly robust, even if periods of volatility persist.

Reduced dependence on the dollar and oil

Historically, emerging market performance has often coincided with a weak dollar. Yet their dependence on the greenback has gradually declined. Foreign-exchange reserves now largely cover short-term debt, while sovereign borrowing flows remain strong.

Oil-related risks should also be viewed with nuance. A sustained rise in energy prices would fuel inflation in some importing countries, such as India. However, in recent years Asia and Latin America have reduced their reliance on hydrocarbons by developing technology sectors, services, and renewable energy.

Towards a gradual decoupling from the dollar zone?

Global monetary balances are evolving rapidly. The Trump administration is exploring the idea of partially backing the dollar with crypto-assets, while Washington is also seeking to use dollar-denominated stablecoins to support demand for US government debt. At the same time, the Chinese yuan is gaining importance in international trade, as Beijing actively pursues its objective of monetary internationalization. Over time, these developments could encourage greater convergence among emerging economies outside the dollar sphere.

An investment theme that remains intact

Against this backdrop, emerging markets continue to offer strong structural arguments. However, the current phase likely marks the end of a broad, homogeneous rally. As across global financial markets, selectivity is becoming crucial. Geopolitical tensions, monetary dynamics, and macroeconomic divergences are likely to increase performance dispersion. In other words, the investment theme remains relevant, but it now calls for a more selective and distinctly tactical approach.