Emerging equities offer compelling valuations, short-term headwinds

In the wake of US tariff announcements on 2 April, emerging market (EM) equities experienced significant declines, in line with US stocks, then rebounded as President Trump paused duties on every economy except China. With the full economic impact of tariffs still uncertain, a depreciating US dollar does not signal a “risk on” environment. Major emerging markets, with the exception of India, are now trading at a discount to their historic average valuations. We remain neutral on EM equities. 

Initial market reactions after 2 April saw the MSCI Emerging Markets Index (MSCI EM) and the MSCI World Index both drop as much as 11%. Since the US administration dialled back its tariffs, excluding China, the EM index has recovered some ground and is now 3% lower, while the MSCI World remains 5% down, and the S&P 500 has lost 7%. Historically, emerging market equity performance has been highly correlated to US stock markets. Since 1990, the S&P 500 has recorded 18 declines of more than 10% with an average fall of 20%, compared to a decline of the MSCI EM of 21%. 

However, US equity declines are typically accompanied by a stronger US dollar, as measured against the DXY basket of developed currencies. Such strengthening ordinarily reflects the dollar’s status as a haven for capital, and international capital’s preference for US financial assets in times of stress. 

That was not what happened after 2 April. Since President Trump unveiled import tariffs, the dollar has declined by around 6%. A weaker US currency would usually suggest a "risk-on" environment as capital flows often broaden to the benefit of emerging equities. But this time, the uncertainties surrounding the US’s erratic trade policy reflect risk aversion, undermining appetite for US assets as a haven. Major emerging currencies, including the Chinese yuan (CNY), Brazilian real (BRL), and South African rand (ZAR), all weakened, while developed market currencies, including the Swiss franc (CHF), euro (EUR), and Canadian dollar (CAD) strengthened against the US dollar.

The uncertainties… reflect risk aversion, undermining appetite for US assets as a haven 

Growth concerns extend beyond the US

Economic fundamentals also drive the relative performance of emerging versus developed market asset prices, in particular the difference between emerging and developed markets’ growth. Over the last two weeks, expectations that US tariffs, which will slow the global economy and specifically target Asian emerging markets, has impacted both US and emerging stock markets. We expect slowing growth to be especially felt in the second and third quarters of 2025. In the light of these challenges, emerging equities are grappling with foreign investor outflows, which year to date total about USD 19 billion, according to JP Morgan. 

Not all equity markets are equally exposed to trade disruptions. Five economies –  China, India, Taiwan, South Korea, and Brazil – account for nearly 80% of the MSCI EM  index’s market cap. Of these, Taiwan and South Korea are the most sensitive to US tariffs (see chart 1). The MSCI Taiwan index’s member companies derive 42% of their revenues from the US, while the comparable figure is 17% for the South Korea index. In contrast, the members of the China, India, and Brazil indexes are relatively insulated, with higher shares of domestic revenue. However, Chinese equities are likely to be affected more significantly through the indirect impact of slowing domestic GDP growth. Much higher tariffs, a larger US trade surplus and secondary effects of its transshipments through Vietnam or Mexico will weigh on the economy and earnings. India and Brazil should experience more minor impacts to their economic growth, with Brazil probably suffering most from declining commodity prices. In addition, strategic tensions between the US and China are pivotal for emerging economies. 

Valuation pressures

Trade uncertainty and declining earnings expectations have put pressure on corporate valuations. Except for India, all regions are trading at a discount to their 10-year median forward price-to-earnings (P/E) ratios (see chart 2). Any recovery in these markets depends on greater trade certainty, either through deals with the US, improving earnings visibility, or outsized stimulus measures from China’s authorities, which at this stage we do not expect.

Except for India, all regions are trading at a discount to their 10-year median forward P/E ratios 

Consensus earnings per share (EPS) growth expectations for 2025 and 2026 are high. Consensus EPS growth for the MSCI EM index is 14% for 2025 and 13% for 2026. China is expected to see 6% growth in 2025 and 12% in 2026. Given low earnings visibility we see a high risk of downward revisions as economic indicators weaken in the second and third quarters of the year. China and Brazil have seen the largest EPS cuts in the last four weeks, while India and South Korea have performed better than average.

Nevertheless, there may be opportunities in emerging market equities once the uncertainty settles. Potential structural shifts, such as a lower US trade deficit and any erosion of trust in US institutions, could lower demand for US assets and drive capital into emerging equities. Rising competition from Chinese technology and a stabilisation of China’s property market, together with an improvement of consumer sentiment, could all boost earnings and demand for emerging equities. 

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India is relatively insulated from the US tariffs and we expect its economy to accelerate in 2025, supported by a rapid decline in inflation, lower commodity prices, interest rate cuts, and the fading drag from fiscal consolidation. India’s nominal GDP may grow as much as 11% in 2025, however, there is a risk that outsized Chinese stimulus forces investors to rotate capital away from India, especially if emerging equities as a whole don’t attract new inflows. 

Neutral stance on China, Brazil

We see China’s economy slowing and expect it to record growth of 4.2% in 2025, falling short of the government’s 5% target. Stimulus measures should offset some damage, but cannot completely make up for the expected contraction in goods exports. We see President Xi Jinping’s commitment to the private sector as a reason to retain some optimism, even if any meaningful trade deal with the US takes many months.

Taiwan and South Korea are the most sensitive to tariffs…, but much is already reflected in their stock markets’ valuations

Taiwan and South Korea are the most sensitive to tariffs and the global slowdown, but much of this is already reflected in their stock markets’ valuations. Both countries are likely to be among the first to strike a trade deal due to the importance of semiconductors for the US. However, neither market typically bottoms before earnings revisions slow, and ongoing uncertainty regarding tariffs on semiconductors remains a concern.

Brazil is still in a rate hiking cycle, and high interest rates are putting pressure on valuations. Despite this, slower global growth could let the central bank cut interest rates sooner. However, the high share of financials and commodities in Brazil’s market is unlikely to perform well if global recession concerns rise.

In conclusion, while EM equities face significant challenges from trade tensions, economic slowdowns, and valuation pressures, there are also potential opportunities for recovery and growth. Investors should remain cautious but attentive to structural and cyclical shifts that could influence market dynamics.