Emerging Markets Are Outperforming Wall Street. The Next Leg of the Rally Looks Much Tougher
Emerging markets missed the memo that 2026 was supposed to be a rough year. Developing-world stocks shrugged off a Middle East war, an energy shock, and a soaring dollar, holding their ground while investors braced for the worst. But after weathering one crisis after another, the rally met its toughest opponent yet: the Federal Reserve.
Role reversal: Investors expected soaring energy costs to hit economies dependent on Middle East imports hard. Instead, the MSCI Emerging Markets Index rallied to fresh record highs faster than the S&P 500, as AI suppliers in South Korea and Taiwan helped cushion the blow from pricier oil. The bond market delivered another surprise, with developed-market debt beginning to behave more like its emerging-market counterparts.
- The emerging markets index gained roughly 14% this year, outpacing the S&P 500's 5.6% rise, with South Korea's Kospi leading the charge.
- Stocks in the iShares MSCI Emerging Markets ETF traded at 18.4 times trailing earnings, compared with 28.9 times for the iShares Core S&P 500 ETF.
The Fed Sends the Bill
September finally broke the streak. Foreign investors pulled $26.3B from emerging-market stocks and bonds, the first monthly outflow since June. The shift came after the Federal Reserve raised rates for the first time since 2023 amid stubborn inflation. Treasury yields rose, the dollar strengthened, and investors began taking profits in chip stocks as the AI-driven rally lost momentum.
- Heavy foreign selling of South Korean stocks drove a $19.2B outflow from emerging market equities last month.
- Traders added over $700M in fresh cash into BlackRock's iShares MSCI Brazil ETF after Brazil's first-round vote.
Selective, not sour: Brazil remains a bright spot, with the real hitting a five-month high as investors bet on fiscal reforms following a potential Bolsonaro runoff victory. Societe Generale strategist Phoenix Kalen expects emerging-market currencies to weaken as investors pull back, though she still favors Brazil, Colombia, India, and Indonesia. As Causeway Capital's Sarah Ketterer cautions, cheap valuations offer some protection, but not against further Fed rate hikes.
