Emerging markets (EMs) have long been touted as the next frontier for superior returns, bolstered by rising incomes, increased infrastructure spending and favourable demographic trends. Many of these economies benefit from younger, growing populations, which translate into robust consumer demand and a vibrant labour force. By contrast, developed markets such as Europe and Japan face rapidly ageing populations and falling birth rates, effectively ensuring negative population growth. This demographic headwind can hamper economic expansion and dampen equity returns, whereas EMs still enjoy the potential tailwind of expanding workforces and consumer bases.
Yet, despite these seemingly advantageous factors, EMs have persistently underperformed their developed market counterparts in recent years. A primary reason for this weakness has been the strength of the US dollar. A firm dollar often leads to tighter financial conditions for countries with dollar-denominated debt. Servicing these loans becomes more expensive, while local currencies weaken, placing pressure on equity returns. In contrast, developed markets, particularly the United States, can more readily absorb rising interest rates and capital costs.
Another significant driver of developed market outperformance has been the extraordinary growth of US technology companies, which constitute a large portion of developed market indices. Over the past decade, mega-cap tech stocks have delivered outsized earnings growth, buoying broader market performance. This concentration of tech-led gains has overshadowed many traditional sectors both in developed and emerging economies. As a result, EM equities, which often lack similarly dominant tech behemoths, have lagged on a relative basis.
Additionally, political and policy uncertainty has weighed on emerging market sentiment. While such instability can affect any country, many EM nations face abrupt leadership changes and shifting economic strategies that can spark volatility. Concerns around governance, transparency and rule of law further deter some investors from committing large amounts of capital, exacerbating the performance gap. There is an opportunity for countries that adapt pro-market, capitalist policies. If one looks at Argentina, for example, it appears as though Javier Milei has finally moved the South American country’s economy in the right direction.
Commodity price fluctuations also play a central role in EM underperformance. Many emerging economies rely heavily on commodities, be it crude oil, metals or agricultural products. However, as China’s once-red-hot economy has slowed, its appetite for raw materials has tempered, putting downward pressure on prices. A broader slump in demand for these resources can disproportionately affect EMs. By contrast, developed economies with more diversified sectors and well-established fiscal buffers can better withstand such shocks. That said, there are reasons to believe EM underperformance could reverse. The US dollar’s multi-year rally may have peaked as President Trump attempts to restore US manufacturing competitiveness. Historically, emerging markets have thrived under a weaker dollar regime, attracting stronger investment flows.
Ultimately, emerging markets tend to outperform when global liquidity improves, commodity prices stabilise and the US dollar weakens. While these catalysts may not align perfectly in the near term, the secular growth story remains compelling – particularly given favourable demographics. A well-considered, selective approach can help investors capture the potential upside when the tide finally turns in favour of emerging markets.