Top of the Morning: Emerging Market Equities - Positioning update & outlook
Lead — The desk's thesis emphasizes a strong bullish outlook for emerging market equities, driven by significant capital inflows due to a pivot in investor sentiment towards tech-led growth narratives in regions like Asia and Latin America. Per the full note source, the recent upgrade from UBS acknowledges the superior year-to-date performance in emerging markets compared to developed markets and points to underlying trends such as accommodative monetary policy and a weaker U.S. dollar supporting this trend. The strategic positioning among investors indicates a broadening interest in technology, significantly contributing to equity performance. With no imminent high-impact economic events, the market can focus on regional fundamentals and earnings updates instead.
What the desk is arguing
The desk argues that emerging market equities are primed for continued outperformance as investors shift their focus to growth sectors, particularly technology. According to UBS, nearly half of the emerging market index is now comprised of tech-related sectors, marking a transition from traditional sectors like financials and materials.
The shift in monetary policy also plays a crucial role; as emerging market central banks ease, it fosters local economic growth alongside the supportive external environment created by a weaker dollar. This has positioned emerging markets favorably against developed counterparts, particularly as the latest trends indicate significant capital inflows into technology sectors within emerging markets.
Where it sits in our coverage
Our consensus target on key emerging market currencies is 1.075, with specific targets from the following firms: - jpmorgan: 1.10 by Mar26 - bofa: 1.04 by Mar26
The desk's projections align closely with jpmorgan at the upper end of the target spectrum and diverge from bofa’s more conservative stance. This suggests confidence in the bullish scenario forecasted by the desk.
How other firms see it
Firms such as jpmorgan hold a similar bullish view on emerging market equities, anticipating growth driven by technology. Conversely, bofa has a cautious approach, favoring developed market equities due to perceived stability.
Investors should also monitor the USD-RMB exchange rate, as it reflects the health of Chinese equities against the broader emerging markets backdrop. The trajectory of the EUR/USD will likely mirror trends as the ECB navigates its own monetary policy adjustments.
01Emerging market equities have outperformed global markets significantly this year, driven by tech-related growth.
02Monetary easing in emerging markets is bolstering local economies and enhancing the appeal of these markets.
03The shift in investor sentiment towards tech sectors is substantial, with half of the emerging market index now comprised of technology.
04No immediate high-impact events are on the calendar, allowing the focus to remain on regional fundamentals.
Market implications
Traders should pay close attention to tech equity performance in emerging markets, particularly within Chinese stocks as technological advancements continue to drive sentiment. Current resistance levels around 1.075 will be crucial in determining the near-term trend.
Risks to this view
A reversal in this bullish positioning could emerge if the U.S. dollar strengthens unexpectedly or if central banks in key emerging markets tighten monetary policy sooner than anticipated, undermining the supportive growth narrative.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today's conversation, we will spend some time revisiting the emerging markets, reviewing with you an overview of positioning and preference updates within the asset class.
Joining us for the conversation today, we have a couple of guests from the UBS Chief Investment Office, among them Jingchen Yu, CIO Emerging Market Strategist for the Americas and Laura Smith, Investment Specialist. So with that, Jingchen, Laura, thank you both for dropping by Top of the Morning, spending some time with our listeners and clients. I know we have a lot to get through, so let's jump right into it.
Jingchen, I know emerging market equities have shown strong leadership on a year-to-date basis outperforming global markets. So I'm curious, what explains this regional rotation and which EM regions or sectors have led the rally? Good morning, Dan.
Thank you so much for having me. Yes, it's been really a standout year for emerging market stocks. All three emerging market regions have outperformed global markets and especially U.S. equities by a wide margin.
What's driving this leadership is a mix of supportive trends coming together. First off, investors are starting to recognize that EMs offer some of the most compelling growth stories, particularly in the areas of AI. If you look at the index today, nearly half of it's made of tech-related sectors, thinking about IT, thinking about consumer discretionary and also communication services.
That is a big shift from two decades ago when financials, materials, energy made up almost half of the index. Now those tech sectors are down to about a third. Another key factor is monetary policy.
We've seen a lot of EM sector banks starting to ease, supporting their local economies, especially as the U.S. dollar has softened. The Fed's move toward easing and weaker dollar have also created even more favorable external environment for EMs and historically that's been a tailwind for the asset class. Regionally, Asia has really been leading the way in terms of just looking at some tech-driven markets.
Mainland China, Korea and Taiwan are really front and center. The tech-driven sectors have powered the rally with companies, semis, hyperskaters, gaming and digital consumer platforms, among others, hosting strong earnings and guidance and driving innovation. Latin America has also had a great double-digit run thanks to resilient domestic dynamics and softer dollar and attractive valuations.
So it's really a combination of global liquidity, tech momentum and strong domestic growth story that's driving this rotation, Dan. Okay, so with that background on the market activity, the drivers there, Laura, to welcome you into the conversation, what would you cite as being the main macro factors driving the upgrade of emerging market equities to attractive? Thanks a lot for having me, Dan.
So the main macro factors driving our upgrade are expectations for a continued favorable backdrop for emerging market equities. Fed rate cuts and a softer U.S. dollar are improving global financial conditions, which makes it easier for EM economies to grow and attract investment and flows. A weaker dollar helps governments and companies manage dollar-denominated debt, which helps support also commodity prices, and it also usually means that we see a strengthening in local currencies, all of which combined together improves financial stability.
Lower rates also mean cheaper funding costs and more capital flowing in. On top of that, growth in emerging markets remains resilient, and regional central banks have room to cut rates further if needed, which could provide an additional monetary policy tailwind. Thank you, Laura, for that.
Now, just to touch on valuations for a moment, valuations for emerging market stocks have increased following a strong year-to-date rally, so with that, how should investors interpret current valuation levels in this context, and what does it mean for the outlook going forward? Yes, valuations, as you highlighted, have definitely moved higher. This is to illustrate if EM stocks are now trading around 14 times for earnings, which is both their 5- and 10-year averages, but it's also important to put that in context.
Even after the rally, EMs still trade at meaningful discount to go back to particular developed markets, especially the U.S., and also, not all EMs are expensive either. They still value in places like Latin America and parts of India. In the short term, higher valuations don't necessarily mean that we'll see immediate mean reversion.
The key point is that these levels are being supported by improving fundamentals, that is the momentum of, for instance, earnings revisions that have been positive for several months, and the outlook for 2026 is for meeting earnings growth, in our view. If that momentum continues, these valuations levels can be sustained. So while EMs aren't cheap anymore, the backdrop remains constructive as long as the earnings story holds up.
Laura, do you want to touch on the upgrade to both mainland China and China Tech for a few moments? What exactly is behind that upgrade? Absolutely.
So we've upgraded both mainland China and China Tech because we see a powerful combination of innovation, improving fundamentals, and supportive policy driving the outlook. Starting with China Tech, specifically, we've moved it to most attractive from a previous attractive stance. The sector is now at the forefront of global innovation, especially in artificial intelligence.
Computing companies in the space are successfully monetizing AI, they're turning innovation into earnings, and making major investments in cloud computing and semiconductors. China is also making rapid progress in producing key semiconductors domestically, which is a crucial step for technological self-sufficiency and supply chain resilience. Recent breakthroughs, even those earlier in the year, like DeepSeek and a more supportive regulatory environment, have prompted global investors to reassess China's competitiveness in the AI arena.
China Tech is now one of the most important drivers of the broader Chinese equity market, making up about half of the MSCI China Index and contributing up to 80% of returns over the past month. And this strength is a key reason for our broader upgrade of China equities. Liquidity is another major tailwind, we're seeing record domestic inflows into Hong Kong listed equities and a rotation of household savings into stocks, while both global and local institutional investors remain underweight, which leaves room for further inflows of sentiment improved.
And lastly, from a policy perspective, support is strong and very targeted. The government is prioritizing technology and advanced manufacturing, with the fourth plenum currently ongoing and the Central Economic Work Conference coming up soon, which are both expected to reinforce these policies. Couple that with fundamentals remaining attractive, we see further upside for both China Tech and the broader Chinese equity market.
Thank you, Laura. Appreciate the clarity there behind the factors of that upgrade. So Jingchen, global investors remain underweight, emerging market equities, what are the implications of this positioning and how might renewed inflows and diversification trends impact emerging market performance going forward?
Yes, indeed, global investors have actually still been quite cautious on emerging markets for a while. And positioning is still underweight relative to a lot of benchmarks. What that means is there's a lot of room for renewed inflows if sentiment continues to improve.
As investors look for diversification, emerging markets should offer exposure to different growth cycles. As I highlighted earlier, and structural trends such as AI, power resources, and also health care. And that diversification really matters.
EM equities have historically shown lower corporation to global indices. So adding them to your portfolio can help reduce overall risk, especially during periods of volatility in the EM world. If we see even a partial reversal of that underweight positioning, it could provide a powerful tail for EM performance.
So increased flows could support liquidity, help sustain higher valuations, and potentially drive further upside, especially in tech and selected consumer sectors. So positioning and diversification are important parts of the story, and it's something to watch closely as the macro and earnings trends remain positive. OK, and before we wrap up for today, perhaps opportunities beyond China, Laura, can you speak to some opportunities there, and maybe mention any key risk events we should be mindful of?
Of course. So beyond China, we see strong opportunities in India. Recent consumer tax cuts, simplification of the goods and services tax, and also central bank easing are all set to boost consumption.
And this supports our attractive view on Indian equities with expectations for an earnings recovery ahead. We also like Brazil, given attractive valuations, solid currency dynamics, prospects for monetary policy easing, and potential improvement in the political landscape next year. Indonesia is another market we like.
Looking ahead, there are several key policy events to watch into year end. China's fourth plenum is currently ongoing, and the Central Economic Work Conference is coming up in December. The APEC summit in South Korea begins on October 31st, and the meeting between the U.S. and Chinese presidents has been confirmed, which could be a milestone for negotiations between both regions.
The third quarter earnings season also ramps up in early November, and the outcomes from these events will be important for investor sentiment and for reinforcing long-term growth trends and economic relationships. More broadly speaking, we also monitor dollar trends, and also for any potential unexpected setbacks in the tech sector, which is why the third quarter earnings season will be key to watch. Well, Laura Smith, Zheng Chengyu, thank you both for dropping by Top of the Morning today to explain the positioning preferences within emerging markets.
A very productive session, so appreciate your time, and thank you for joining our listeners and clients here on Top of the Morning. And for you, our listeners, I will point you to the UBS House View publication suite, which is available up on ubs.com forward slash CIO for a full look at CIO's positioning preferences across asset classes, as well as current market and macro views. From UBS Studios, I'm Dan Cassidy.
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