Why this time really might be different for emerging markets and SA

Of all the trades this year, perhaps the most surprising has been the outperformance of an asset class long shunned by global investors: emerging markets. After more than a decade of disappointing returns and repeated false dawns, these economies – often seen as perpetually stuck in cycles of boom, bust and political uncertainty – have staged a compelling comeback.

Going into 2025, the one thing that investors and market pundits all seemed to agree on was the narrative of “American exceptionalism”. US equities had outperformed all others for years, largely on the back of the supercharged Magnificent 7 tech stocks. The year 2025 was simply meant to follow a familiar pattern. Why bother with taking the added political risk and uncertainty of investing in “Global South” markets when you could outperform by simply allocating to the world’s largest and most powerful economy?

Yet it has not turned out that way at all.

An MSCI benchmark index of emerging-market stocks has risen 28% so far this year, its biggest gain over the same period since 2009, while a JPMorgan index of government bonds sold by developing countries in their own currencies is up 16%, in a growing comeback from a “lost decade” in the shadow of US markets. This rally in emerging market stocks has far outpaced gains in advanced economies; an MSCI index of developed market stocks is up less than 17% so far this year.

It marks a striking turnaround from the previous 15 years. Emerging market stocks massively underperformed one of the greatest US bull runs in history between 2010 and 2024, with the MSCI Emerging Market Index gaining less than 9% over that entire period after its early 2000s rally collapsed into perennial cycles of boom and bust, and serial underperformance. For those invested in South African equities, this will sound all too familiar.

After a decade and a half of mediocre performance, the stars seem to finally be aligning for emerging markets. What has precipitated this shift?

Tailwinds for emerging markets

First, and perhaps most obviously, is the fall in the the dollar, down almost 10% this year against a basket of currencies, according to Bloomberg data.

A weak dollar usually eases financial conditions in developing countries, by making it cheaper to service dollar-denominated debts. The Federal Reserve’s shift to cutting US interest rates has also supported dollar-funded bets on local currency bonds that still have relatively high yields when adjusted for inflation.

Central banks in bigger emerging markets such as Brazil and South Africa have continued to keep an extremely hawkish stance on inflation, as paragons of monetary prudence and central bank independence. An example of this is the SA Reserve Bank’s monetary policy shift, tightening its inflation target to an explicit 3% from the previous banded approach.

Read more: SA shifts inflation target in bold move

This was a clear signal of intent to bond investors. South Africa’s local 10-year bond is trading at levels not seen for more than 10 years, with its yield now lower than 8.5%.

As for equities, while in South Africa much of the outperformance has been due to the extraordinary run in gold stocks – Nedbank strategists calculate that as much as 80% of the return of the Top40 this year has been down to gold and platinum miners – this is not to say other more general stocks have not also benefitted from lower interest rates and stronger economic fundamentals. Economic bellwethers such as telecom stocks and Real Estate Investment Trusts (REITS) have all had an excellent 2025.

The end of US exceptionalism

But there is a more general dynamic at play. The revival of investor interest in emerging markets reflects the dusk of US exceptionalism, with the US behaving much more like an emerging market itself through erratic and volatile policymaking.

For decades, investors treated emerging-market bonds as the high-yield, high-risk corner of global fixed income, and their equities a similarly speculative bet. Political instability, fragile institutions, inflationary surges and sudden currency devaluations were presumed to be permanent features of developing countries. Developed economies, by contrast, were viewed as stewards of sober economic management, predictable policymaking and institutional stability.

Those assumptions no longer hold.

The fiscal position of many advanced economies has deteriorated sharply since the Covid-19 pandemic. The US, which provides the benchmark for global “risk-free” assets in the form of Treasuries, now runs a seemingly permanent fiscal deficit of more than 6% of GDP and a debt-to-GDP ratio near 120%; both levels typically associated with sovereigns under pressure. Japan’s ratio exceeds 230%, while in Europe, ageing populations and persistent spending commitments are raising debt burdens.

Moreover, geopolitical risk is increasing in developed economies, which can no longer be seen as such safe havens. Electoral volatility, polarised politics and unpredictable policy swings in the US and Europe are eroding long-held perceptions of stability.

Ratings agencies have taken note; Moody’s downgraded the United States in May, citing governance concerns and fiscal slippage, and Scope Ratings followed with its own downgrade in October. France, too, experienced a downgrade in 2025, with S&P Global Ratings moving it to A+ from AA- in October. The boundary between “safe” and “risky” debt is blurring.

Contrast that with the evolution of many emerging markets where debt metrics are becoming more benign. According to International Monetary Fund data, the median emerging market public-debt-to-GDP ratio is about 70%, much lower than the 112% in advanced economies. Several frontier and middle-income sovereigns, notably Indonesia, India and the Gulf states, have implemented medium-term fiscal frameworks aimed at preserving debt sustainability while supporting infrastructure and social spending.

South Africa, too, has made progress. Last month S&P Global Ratings upgraded SA’s sovereign rating to BB, the country’s first credit upgrade in two decades, citing improved fiscal performance and momentum on structural reforms. For a nation long held up as an emblem of emerging market fragility, the upgrade signals how much the landscape has changed. India also saw an upgrade from S&P Global Ratings in August.

Can they continue to get stronger?

Where to from here? A large share of this year’s equity performance reflects “re-rating”; investors have increased the price they are willing to pay for future earnings, rather than responding to major changes in immediate fundamentals. But even so, emerging market equities remain inexpensive relative to US stocks. The MSCI emerging market index trades at roughly 14 times expected earnings for the coming year, compared with more than 23 times for the S&P 500.

This valuation gap theoretically leaves room for further upside, assuming the supportive macroeconomic backdrop continues. A weaker dollar, lower US interest rates, improving domestic policy frameworks, and moderating inflation across emerging economies all point toward the potential for continued strength into 2026.

Of course, emerging markets have disappointed investors many times just as optimism appeared justified. Political shocks, commodity price swings, and a global macro surprise like a recession could change things very rapidly.

Yet the contrast between stretched US valuations and improving emerging market fundamentals is becoming harder to ignore. With fiscal and political strains mounting in the developed world, investors no longer have the luxury of treating emerging markets as a sideshow. DM

Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.