Introduction

The key global theme of 2025 was US policies. Our US ‘policy constraints’ framework published in last year's outlook has been a useful investment tool. As anticipated, bouts of market volatility led US President Trump to soften his trade measures numerous times, with political pressure over higher prices also leading to further climb-downs of tariffs this autumn. But in the end, higher US tariffs were put in place than most investors expected, with the US weighted average tariff rising from around 2% to nearly 15%, albeit down from the low-20s at the peak of trade tensions.

This major policy shift, alongside questions over institutional deterioration, led to a re-evaluation of ‘US exceptionalism’ throughout the year, which supported emerging market (EM) asset outperformance. As we expected, out of consensus, it also led to a weakening of the US dollar and a positive for EMFX. It did not wreak the economic havoc that most predicted, thanks to the resilience and flexibility of global supply chains. Tariff revenues also led to some fiscal consolidation in the US this year, with the US deficit declining from 7.0% of GDP in 2024 to 5.8% as at Q3 2025. Albeit a small improvement, this is certainly not irrelevant and together with weaker growth meant US bond yields have fallen significantly since January. Lower US rates have kept the USD softer, giving more room for central banks around the world to cut. This has supported financial conditions globally. More favourable macro along with economic resilience and sound policymaking drove emerging market asset outperformance for the third consecutive year in fixed income, and the first year since 2020 in equities.

Tariffs will likely be a fading theme in 2026 but will likely continue to affect US inflation and growth. The rerouting of Chinese exports away from the US and towards Europe and EM is having significant deflationary effects and will continue to do so, even as Sino-American trade relations are now improving. But with peak tariff risk in the rear-view mirror, the market is now focusing on new narratives. The ones to monitor most closely are:

1. The AI capex cycle will remain key both for the global economy and markets. In our view, the sequencing of AI’s impact on macro will be the most important dynamic to monitor in 2026. We see the first order effect of AI as disinflationary, or outright deflationary in 2026. The primary channel of this will be via the labour markets.
2. China doubling down on its export-led development model will keep bringing waves of deflationary impulse to the world.
3. The monetary debasement narrative. Fiscal concerns remain front-and-centre on investors' radar. However, we find the debasement narrative to be stale and not firmly corroborated by the current data and the AI deflationary waves, particularly as…
4. …. geopolitical risks are easing, with certain exceptions such as in Venezuela.
5. EM ex-China GDP growth keeps inching up. We see upside risks for GDP growth in many key EM countries, including China, India, Indonesia, Mexico, Brazil, South Africa and frontier market (FM) economies implementing ongoing adjustments
6. EM equities are likely to outperform as investors focus on asymmetric return profiles such as Latin American equities. Contrarian investors should keep an eye on China’s consumption and real estate.
7. Credit spreads remain tight, but all-in yields and improved fundamentals in EM debt offer the potential for good risk-adjusted returns, particularly relative to other debt markets. EM local currency has the potential to deliver another year of double-digit returns.

1 | 2026 Outlook driven by the AI capex cycle

Despite bubble fears, the AI capex super-cycle continues to be the engine driving GDP growth in the US, exports in North Asia and to a certain extent, global risk sentiment. This dynamic will persist next year, in our view. The investment implications of this structural shift in technology are huge, both in macroeconomic terms and for the earnings of exposed companies. Though the epicentre of investment will remain the US, it is very much a global theme. Further upstream in supply chains, many of the companies that stand to benefit most are EM-based.

Underpinning the strength and length of this investment cycle will be global liquidity conditions and borrowing costs. Should liquidity remain supple next year, and rates continue to fall, the bar for AI-related assets to keep performing will be considerably lower. We see an element of micro-to-macro circularity here. If AI proves to be deflationary next year through higher productivity and lower employment, as we suspect it will, central banks will have more room to ease monetary policy, supporting liquidity and a further softening of the USD. At some stage, bottlenecks in energy, metals and credit will likely become a reality and will bring some inflationary friction to the buildout of AI capacity. Yet, these factors are not yet evident constraints at this stage and therefore are unlikely to be the main story for next year. 

Like many investment booms, we see AI working primarily as a deflationary force. This is related to its ability to boost productivity by leveraging computing power to solve day-to-day problems and optimise processes. In the long-term, innovation will create new industries and new jobs. The buildout of AI capacity itself will also create many new jobs in datacentres, energy generation and other adjacent industries. But AI productivity gains will likely cause more job losses than gains as AI adoption broadens across industries. As legacy business models are shaken up in the next quarters across multiple areas of the world economy, we find it difficult to see how AI won’t be an upwards force on unemployment rates in the US and indeed globally.US unemployment remains low at 4.3% but has already risen to its highest point since 2021. If the labour supply hadn’t stopped growing this year, which it did due to Trump’s aggressive immigration policies, the number would very likely be higher. Now, if joblessness continues to rise in the US amidst AI disruption and low hiring – the Fed will most likely cut rates down below 3% in 2026.

A moderate increase in unemployment rates is unlikely to de-rail the acceleration of capex plans. Importantly, easier financial conditions would allow for an increase in breadth of economic performance, and a broadening of market returns into cyclical sectors, which have been in a downturn since 2022. But most importantly for investors in emerging economies, the Fed lowering rates will give more room for global central banks to lower rates too, particularly in EM where real rates are elevated in many cases.

In our view, this provides a solid backdrop for another year of EM asset performance particularly in local bonds and equities. Differentiation across asset class will be key in 2026, with the focus shifting back towards micro drivers. 

b. AI and macro: a 'double-S curve'

Much of the slowdown in hiring in the US jobs market this year has related to tariff uncertainty, and the overhang of the very tight job markets in the two years post-COVID. However, commentary from corporate America makes it clear that efficiency gains are set to drive job cuts in the coming years. AI adoption is already benefiting companies outside of the IT sector. Warehouses were the leading sector for US job announcements in October. It is very likely that this sector, with razor-thin margins, is accelerating automation because of the import tariffs imposed by Trump. Creative (jobs) destruction across a broader set of industries can de disinflationary, or even outright deflationary, if the Fed doesn’t react early enough.

The higher price from tariffs and fears of job losses means that consumer confidence has now softened, which is also leading to a hit on consumer discretionary names in the US. The University of Michigan Consumer Sentiment Index fell to 51 last month, the lowest since 2022, and the second lowest ever. Weak sentiment, alongside the fact that China will keep exporting deflation to the rest of the world for the foreseeable future (see China section) means we are likely to see further disinflation in the short term during the first leg of the AI “double S-curve” as per Fig. 3: 

If AI maintains its breakneck pace of development and growth, increased adoption will likely bring material constraints. The most obvious of these will be electricity. If the hyperscalers’ capex plans are fully implemented, analysts expect demand for energy from AI in the US to increase by 50% by 2030, even after allowing for an estimated 30% efficiency gain from technology.

The key question is the timing of the real-world constraints. Energy supply is currently abundant globally. The US Energy Information Administration (EIA) and JP Morgan see the oil and gas markets in a surplus throughout 2026. However, several studies suggest energy could become a constraint towards the end of 2026 or in 2027.¹

This is also likely to be the time when electricity generation becomes a constraint, particular in the US. This may be the point when AI reaches the second plateau of our stylised “double S-curve” thesis. A disinflationary credit creation before the real-world constraints is our running working hypothesis.

c. China and US face different constraints on AI

How supply constraints are managed may ultimately end up defining the outcomes of the ongoing ‘AI-race’ between the US and China. China has constraints around supply of GPU clusters. The US not only dominates the production of advanced semiconductor hardware but also has more specialised engineers. However, China has much more abundant supplies of key strategic metals and energy, as per Fig. 5. China also has a much larger number of internet users and has had faster adoption. China’s dominance in strategic metals and rare earths gives it ‘escalation dominance’ in any trade dispute with the US in the short term.

But perhaps the crucial difference lies in the countries’ different approaches to monetising the technology. China’s engineers in the manufacturing sector have been very successful at optimising processes and accelerating automation. Advanced manufacturing that benefits from AI includes self-driving cars, humanoid robots, and the low-altitude economy (drones for delivery and transportation). While the largest companies in the US are spending huge resources on an artificial general intelligence (AGI) ‘race’, China is focusing on optimisation. That means China could become a big loser in the future if it doesn’t manage to catch up quickly at the cutting edge of AI tech. But on the other hand, given China’s lack of constraints around energy, it stands a better chance of monetising AI tech more effectively through productivity increases in its economy. 

d. The malinvestment hypothesis

Not all AI-related investment will be successful. But the broad malinvestment hypothesis is unlikely to be accurate. AI has already been driving tangible increases in productivity for the leading adopters. Technology companies have been increasing earnings while reducing headcount. It is hard to argue that the hyperscalers investing in their cloud businesses face a material risk of malinvestment, given their oligopolistic position provides the lifeblood of the modern and future economy: compute power. 

For the non-core companies, the question is more nuanced. Investors have been cautious about ambitious AI investment plans for companies without a clear business case demonstrating a high internal rate of return (IRR) and cash generation. The recent performance of Meta shares  Oracle credit default swaps in the US and property search platform Rightmove in the UK illustrate this point. As in any technology cycle, there will be many companies that won’t deliver the return on investment from their AI capex spending and will disappear (or become too small), while a small number of companies will likely see a substantial increase in their market cap.

2 | China exporting deflation to RoW

The other macro trend justifying a goldilocks environment for asset prices next year is the export of Chinese deflation to its trade partners. China has one of the highest national savings rates in the world, high enough to fund very high levels of investment (circa. 40% GDP) and run a current account surplus (Savings – Investment = Current Account Balance). 

However, structuring the economy in this way has led to major imbalances (too much supply, too little demand) which led to a crash in housing prices in 2021 and has now brought about a broader deflation problem (see China outlook section below).

Since September 2024, China has been implementing policies to boost retail sales and address this problem. Recent emphasis has been put on boosting service sector consumption, which can be an important source of employment. Investments in improving the social safety net, particularly pensions for rural employees, will be taken gradually. However, the piecemeal approach China is taking to rebalancing its economy indicates that the deflationary environment is likely to stay in place for the foreseeable future. Rather than making consumption the top priority, the readout of the 15^th Five Year Plan that came out of October’s fourth plenum put the clearest emphasis on investing further to boost productivity across the Chinese high value add manufacturing sector. China then hopes leadership in high-tech sectors can raise companies’ earnings and subsequently salaries and consumption. This can happen, but will be a long-term process.

In a world where the US external accounts are expected to rebalance only gently over four years due to tariffs, China will probably keep gaining market share in global manufacturing. Goldman Sachs revised its forecast for Chinese GDP growth to 4.8% in 2026, up from 4.0%, led by increasing exports. But as Chinese producer prices remain in deflation, exporting more goods to trade partners will continue to drive prices lower in their economies. 

Germany has been the main loser of the Chinese boom in high value add manufacturing, particularly electric vehicles and industrial machinery. For the German industries hollowed out by Chinese competition the EUR 1trn defence, infrastructure, and energy capex has been little consolation, so far. Germany has shifted from a trade surplus with China just two years ago to a monthly deficit of around USD2bn today. And because China remains an important market for European manufacturers, the disrupted industries are reluctant to support tariffs of Chinese products.

Countries whose supply chains are complementary to China’s, such as Taiwan, South Korea and Malaysia have been benefiting from the Chinese manufacturing boom with cheaper inputs leading to greater profits in their outputs. However, they also may lose out if China becomes a ubiquitous exporter of lower value-add memory chips – something that has not yet happened given the large domestic demand for Chinese chips. Other countries like Thailand, have received large investments from Chinese EV companies, but their traditional auto sector supply chain has been cannibalised in the process. As China becomes more assertive, industries such as the low altitude economy (delivery and even transport drones), aircraft (competing with Boeing and Airbus duopoly), shipping, aerospace, and other heavy machinery industries can also suffer under Chinese competition. 

But for now, the key impact across EM is the fact that as China's export volumes increase and producer prices decline (Fig. 8) China will continue to export deflation to the rest of EM. This trend, alongside the disinflationary impact from AI, will add momentum for central banks to cut policy rates, setting up a ‘goldilocks’ macro environment of stable growth and very low inflation.

US inflation does remain above target but is largely under control after 3 years of the Federal Reserve maintaining policy rates above inflation. We are in a world where US nominal GDP growth exceeds the nominal cost of debt, which helps support debt sustainability dynamics. But because the nominal interest rate exceeds inflation, this does not constitute debt debasement. Holders of government debt receive positive real return. Any further disinflationary impulse, such as from AI, would then constitute a full 180o away from debasement. 

The US is not alone in its efforts to stabilise its debt. Italy has taken steps to reduce debt burdens and improve primary balances, even if debt-to-GDP ratios remain very high and, in Italy’s case, have recently inched up again. The UK and France are being forced into tighter fiscal policy by market pressure and EU rules. Japan is an outlier – it has stabilised debt-ratios in recent years but is now flirting with debasement dynamics again by bringing the fiscal deficit back towards 3% at a time when monetary policy is very expansionist, with real rates still at deep negative levels. 

Can the US keep consolidating its deficit? Tariff revenues are on track to reach around 0.5% of GDP in 2025 and possibly 1.0% of GDP or more in 2026. Any adjustment won’t be linear. The One Big Beautiful Bill Act (OBBBA) has incentives for research & development and manufacturing investment which will offset the tariff revenues in 2026. On the other hand, as AI capex-driven private sector growth accelerates, this will broaden the tax base, which could support a more sustainable consolidation. Because tariffs are likely to become a permanent revenue source, as the capex incentives gradually phase down, the US can plausibly move back onto a fiscal consolidation path in 2027 and 2028.

If AI is indeed disinflationary, as we expect it to be, the global macro picture will turn closer to goldilocks than to debasement next year. High growth, low inflation, and positive real rates even as central banks cut further. In this environment, government debt ratios can stabilise (nominal growth > average interest rate) but for the right reasons. This is particularly true considering that geopolitical risks are de-escalating.

4 | Geopolitics: Improving after an ugly 2022-2024

Taiwan Strait

Tensions between China and Taiwan are likely to remain elevated in 2026. This year saw major military exercises in the strait from both sides. China held a two-day exercise “Strait Thunder-2025A”, involving the most naval vessels in nearly a year. From 9-18 July, Taiwan held its largest-ever Han Kuang military exercise, involving the biggest mobilisation of reservists and extending to 10 days to improve its response to Chinese "grey zone" tactics. 

Domestic defence commitments have also accelerated. In August, Taiwan’s President Lai Ching-te announced a plan to lift defence spending to 5% of GDP by 2030, a move that coincided with renewed geopolitical concerns and ended an eight-week streak of foreign equity inflows, with outflows reaching –USD 4.1bn. Taiwan later proposed a 23% increase in its 2026 defence budget to TWD 949.5 bn, aligning with U.S. calls for greater regional burden-sharing.  In November, the government distributed 11m national security handbooks to households, offering guidance on emergency preparedness - signalling ongoing concern over potential contingency scenarios.

Nevertheless, the likelihood of a blockade or invasion remains low in the near term in our view. The economic costs would be severe: Taiwan controls over 60% of global semiconductor manufacturing capacity, including more than 90% of leading-edge chip production. China’s reliance on export-led growth, and foreign demand for its products, makes it very sensitive to the global growth demand shock a bottleneck in semiconductors would create. Moreover, at a time when China’s domestic economy is weak, it would find it hard to deal with the high sanctions and tariffs which would likely arise from an act of aggression towards Taiwan next year. The ongoing purging of the People’s Liberation Army leadership is another signal. Long-term, a reunification of China and Taiwan remains a high risk, but the current economic backdrop creates strong disincentives for any large-scale conflict going into 2026.

Middle East 

From an investment perspective, the key reduction in geopolitical risk in the Middle East came after the US brokered a summer ceasefire between Israel and Iran. This reduced the major risk to oil supply, which was Iran blocking the strait of Hormuz. The recent Israel/Hamas ceasefire and hostage deal that took effect on 10 October has improved the situation further. Brent is now trading in the mid-$60s, roughly 15% below its 12-day-war peak. 

Nevertheless, the broader regional backdrop remains highly unsettled. Gaza remains an unsolved situation, with millions of people displaced and almost daily skirmishes between Hamas and the Israeli Defence Forces (IDF) ongoing. The short war between Israel, Iran and the US, including US-Israeli strikes on Iran’s nuclear facilities at Natanz, Fordow and Isfahan (and Iran’s retaliatory missile attack on the Al Udeid base in Qatar) ended without regime change in Iran. It also left Iran’s nuclear programme damaged but not destroyed. The International Atomic Energy Agency (IAEA) estimates that around 400kg of 60%-enriched uranium remains, while Tehran has suspended cooperation with the Agency. As Israel continues tactical strikes across the region, including on Hezbollah leaders in Beirut this month, Iran’s condemnation, and threats of renewed direct confrontation are rising.

It is a fragile equilibrium, but more stable than 24 months ago. There has been a political transition in Syria and Hezbollah is much weakened in Lebanon, a country now discussing and implementing structural reforms. The engagement of international authorities, led by the International Monetary Foundation (IMF) raises hopes of a gradual but lasting political-economic normalisation in Lebanon. Despite the backlash against Israel’s campaign in Gaza across the Middle East and the world, the Abraham Accords are holding and an Israeli rapprochement with Saudi Arabia is under discussion behind the scenes.

In the meantime, the macro data is improving. The IMF now expects Middle East North Africa (MENA) growth of about 3.3% in 2025 and 3.7% in 2026, helped by higher oil output, strong non-oil activity in the GCC and easing inflation, which is projected to stay below 2% in many Gulf economies. Middle East sovereigns continue to show ratings resilience, with reforms and strong buffers meaning no issuer sits below CCC+ for the first time since 2019.

Ukraine 

This year Trump’s Alaska and Washington diplomacy raised expectations but has delivered little progress so far, with news flow focused on Russia–NATO and energy risks, though we still judge the balance of risks to favour eventual de-escalation over a wider conflict. 

Airspace incidents across Poland, Estonia and the Nordics highlight a pattern of Russia testing NATO boundaries. Ukraine faces a USD 65bn funding gap across 2026–27, with only about half of next year’s financing clearly identified. The EU’s effort to use frozen Russian assets as collateral for long-term “reparation loans” could stabilise Ukraine’s funding path, though it may also enable the conflict to be sustained for longer.

At the same time, the Russian economy has slowed to near stagnation after the 2023–24 boom, and the 2026 budget raises VAT from 20% to 22% while holding defence spending flat to contain the deficit. These measures increase pressure, but not yet to the point where the Kremlin is prepared to adjust its strategic objectives going into 2026. Structural damage to Russia’s refining sector — with close to 20% of capacity offline at points — also limits any sharp post-war recovery in fuel exports.

The diplomatic landscape has shifted with Washington now revising its peace plan after strong European and Ukrainian resistance to the initial 28-point proposal released in late November. Kyiv and European partners are pushing for firmer security guarantees, protection of sovereignty and clearer reconstruction commitments. Moscow continues to reject key elements, but the White House’s more assertive tone — including the threat to sanction Russian oil exports — and deeper behind-the-scenes engagement suggest that negotiations are entering a more active phase. Overall, the path to a ceasefire remains uncertain, but the direction of U.S. policy still points toward managed de-escalation rather than renewed escalation.

Eastern Europe: Supported by the EU Defence Capex 

The EU is moving into a multi-year defence investment phase, anchored by Security Action for Europe (SAFE) (EUR 150bn) loans, Recovery and Resilience Facility (RRF) funds and Cohesion funds. This represents the largest structural fiscal impulse in the Central and Eastern Europe (CEE) region since EU accession. The programme will support growth, lift industrial demand, and keep local curves steep via higher issuance. CEE, particularly Poland, is the standout beneficiary, combining defence capex, EU fund inflows, domestic demand strength and upcoming monetary easing. Romania benefits too, but stability will determine the degree of market participation.

Poland is already the most dynamic defence investor in the EU. Its defence budget will approach 5% of GDP by 2026, the highest in NATO, after record PLN 200bn outlays in 2025, equivalent to 4.8% of GDP.  Poland is also the largest beneficiary of EU support. The Polish army is set to receiving almost €45bn under SAFE, with disbursements beginning early 2026, on top of the €39bn in RRF and Cohesion funds still to be deployed by the August 2026 deadline. 

These inflows reinforce an already strong domestic economic cycle: real wages are rising sharply, keeping consumption robust. At the same time, low inflation means the market sees the National Bank of Poland cutting its policy rate by 75bps over 2026, which may revive credit after several stagnant years. Romania is also increasing defence investment but needs to prioritise its significant fiscal reform programme, in our view. The deficit is projected to narrow from -7.1% in 2024 to -4.8% in 2025, but political resistance from unions and pension groups risks diluting the ambitious consolidation. Progress on fiscal alignment is needed to unlock the next EUR 3-4bn RRF tranche by early 2026.

The return of the Monroe Doctrine: Venezuela

The US is imposing significant pressure on the Venezuelan regime of Nicholas Maduro. In late 2025, the US military hit 21 Venezuelan vessels in international waters that were suspected of trafficking drugs, resulting in at least 83 deaths. This came alongside a significant military buildup in the Caribbean involving c. 15k personnel and key assets like the USS Gerald R. Ford carrier strike group. Diplomatic pressure escalated with the designation of the "Cartel de los Soles," allegedly led by Maduro, as a Foreign Terrorist Organization, the doubling of a reward for Maduro's arrest, and the end of diplomatic talks. The "terrorist" designation leaves Maduro vulnerable to U.S. intelligence and military action. The regime's long-standing accusations of U.S. imperialism are now underpinned by concrete actions targeting its alleged deep connections to Latin American drug cartels.

Notably, explicit support for the Maduro regime from other Latin American countries has been minimal, save for Colombia's Gustavo Petro—a sign of geopolitical pragmatism. Security is a primary voter concern across the region, making association with a designated narco-terrorist state politically unviable. The Trump administration's posture signals a return of the Monroe Doctrine: aligned leaders, like Argentina's, receive support, while foes face hard persecution. Leaders and voters better take note of the changing times.

5 | Global economic growth vs. Inflation: Where consensus can be wrong

Fig. 10 shows the consensus expectations of the sell-side economists we follow across the major economies in both EM and DM. Growth is expected to stabilise across DM and EMs. EM GDP is likely to decline at the margin due to China, where the median forecast has GDP growth falling from 4.8% in 2025 to 4.3% in 2026. EM ex-China is expected to inch up, although India – the largest country in EM-ex China – is expected to flatline at 6.7%. DM growth is expected to tick down, with Japan and the US the main culprits of softness.

Versus consensus, we think that risk is skewed to the upside for each of these large countries, given our view that global interest rates continue to fall next year, and the passing of tariff-related uncertainty releasing pent-up demand for capex:

• In China, further export expansion amid cooling trade tensions can be the key driver of an upside growth surprise, in our view. Domestic consumption will likely remain soft, given low consumer confidence. However, accommodative monetary policy and the likelihood of further fiscal measures to support demand should keep consumption somewhat supported.
• In EM ex-China, growth upside could come from a cyclical recovery in India, founded in lower interest rates and a re-acceleration in infrastructure investment, with banking sector liquidity now in much better shape, having been negative in early 2025. Indonesia is also enacting pro-growth policies. If it manages to regain credibility that more social security can be provided and state-owned enterprise (SOE) capex can increase without an increase in the fiscal deficits, private sector sentiment can improve.
• In Latin America, the economic transition from the left to the right will bring liberal economic policies, possibly leading to an improvement in moribund investment sentiment. Mexico can regain its mojo post-USMCA review, which is likely to be approved by next summer. Brazil will be once again supported by fiscal policy with a large income tax cut counterbalancing  tight liquidity conditions from elevated interest rates. Policy seems to be working as inflation expectations are declining.
• South Africa may see its economy supported by higher mining prices, lower electricity and logistics bottlenecks, and better fiscal management that has put the country on a path to regain investment grade within a few years. The lowering of the inflation target can support real economic growth via lower interest rates. Other African economies, including Nigeria, Ghana, and Zambia will continue to benefit from better macro stability, presenting upside potential to growth across the continent. Senegal and Kenya are likely to stabilise their debt burdens, as well, supported by the IMF and reformist governments.
• In the US, the continuation of the AI capex cycle can keep growth buoyant. But if AI keeps driving a softer labour market, the Fed will eventually lower interest rates by more than priced, which is likely to support a broadening of growth across the economy led by a cyclical recovery in downtrodden manufacturing sectors, as well as the housing market. The election of Sanae Takaichi as Japan’s new PM makes it unlikely that growth will decelerate in 2026 given her expansive, pro-growth policy stance. 

Of course, risks to consensus are always two-sided. But macro uncertainty is less elevated than it was last year, in our view, where there was a larger tail risk of a tariff-driven global recession. Geopolitical risks are also subsidising, lowering the upside risks to inflation. The key risk to global markets in 2026 is an early end to the cutting cycle in the US if inflation accelerates, driving rates wider and the Dollar higher.. This would lead to a tightening of global financial conditions, with rate-cutting cycles in other countries also stalling, and credit spreads widening. 

However, we see this scenario as unlikely, given our view that AI will be disinflationary, particularly in the US, via the jobs market. China continuing to expand its trade balance with the world ex-US will be another important deflationary impulse, particularly in Asia, which should ensure monetary policy remains accommodative. The combination of these two macro factors leaves room for inflation to surprise to the downside relative to consensus estimations for 2026 in the US and EM-ex China. Lower rates, and less policy uncertainty stemming from the US, may be key factors in driving an improvement in business conditions worldwide. 

6 | 2026 Outlook for EM equities

Last year’s Outlook highlighted that the valuation disparity between US and EM equities (EME) had reached record highs and pointed out the high probability of a return towards the mean. The thesis rested on a rebound on the earnings per share of EME, driven by Asian technology and China. This played out this year, as EM equities posted a strong outperformance over both S&P 500 and DM stocks more broadly (MSCI World). Despite the EM outperformance, the valuation gap remains wide. The S&P 500 forward price-to-earnings (P/E) valuation is currently at c. 22.4x, roughly the same as last year. Meanwhile, MSCI EM’s valuation by the same metric has risen from 11.8x to 13.3x today. The earnings yield implied by these valuations is 4.5% in the US and 7.5% in EM, with the first trading two standard deviations expensive to 10-year US Treasuries, and the latter trading nearly 3% above the weighted average EM 10-year local currency bond in EM. In other words, US equities remain expensive, both against US fixed income and EM equities.

This mild convergence in valuation explains about half of the outperformance of EM stocks year-to-date (YTD). Currency has also played an important role, with MSCI EM currencies up 6% vs the DXY YTD. The rest comes from stronger earnings. MSCI EM has seen 13.5% growth in earnings-per-share (EPS) YTD, vs 11% in US stocks. But a bigger factor than strong trailing earnings growth is accelerating EPS growth expectations, which have kept forward-looking valuations attractive. Bloomberg consensus estimates now indicate 18% earnings growth in EM over the next 12 months. 

Much of this growth is expected to come from some of the largest companies in the index, such as TSMC and SK HYNIX. These are two of the biggest and best semiconductor manufacturers in the world. A slowdown in AI capex would put these lofty earnings at risk. But earnings growth drivers across the EM index are diverse. If EM stocks can meet these earnings expectations, or even get close, they are likely to attract further capital flows which will support valuations further, particularly in smaller EM markets. The prospect of near 20% earnings growth in EM next year, along with the potential for further re-rating higher, should be front-of-mind for any global asset allocators still holding underweights in EM equities. 

a. The Asian tech cycle

Asian equity markets this year have been generally positive, and the outlook remains bullish. The top performer, by far, has been Korea. After trading in the doldrums since 2022, Korea has been on fire this year, driven primarily by rapid earnings expansion from Samsung and SK Hynix, as demand and prices for memory chips has surged. The rally can be sustained, in our view. Valuations remain very cheap, with the MSCI Korea trading at just 10x earnings. Given multi-year global AI capex plans, it is likely that high demand for advanced DRAM, HBM and NAND memory chips will be sustained, and likely be less volatile than in previous cycles. Supply of these chips is also likely to remain constrained – with buildout of extra capacity taking years, not months – and companies holding very conservative capex guidance despite all the enthusiasm in the US. Moreover, the value-up initiative is starting to bear fruit. The equity market should trade at higher levels of valuations if companies deliver best practices that support minority shareholders.

Taiwan is benefitting from the same AI capex tailwinds, with another strong year for the index taking three-year cumulative returns to close to 100%. TSMC remains the sole company in the world capable of manufacturing the most advanced semiconductors, and its moat looks highly secure for now. 

China has also seen some rerating in its tech sector, as global investors have come to realise that the ‘Red Dragon’ is not as far behind in the global AI race as many initially thought. The release of cutting-edge DeepSeek and dozens of similar models – put together entirely by Chinese developers who were educated in China – put paid to this notion. . Most of the recent LLM releases in China are open source, allowing adopters to customise the models to their needs. Importantly, instead of pursuing ubiquitous AGI, China is focusing on using AI to boost manufacturing processes and service sector productivity. Loose monetary and fiscal policy in China are keeping liquidity ample, with flows into the stock market boosting valuations this year and driving strong performance. Lowering tariff risk can be a catalyst for further Chinese equity appreciation next year, even as the traditional economy stays soft. 

Indian equities have lagged this year and remain more closely correlated to the domestic economy than Chinese, Taiwanese or Korean stocks, which are currently more levered to technology cycles. After a cyclical slowdown in 2025, macroeconomic indicators in India are looking increasingly positive with credit demand improving, investment rising again and rates likely to fall further next year with inflation contained. The country may still face temporary headwinds, driven by large managers cutting their underweight in China, funded by India. But we are  close to the point, in terms of valuations, that Indian markets become attractive as well and regains our preference in the largest EM equity markets.

Indonesian equities rebounded recently supported by strong domestic demand and ongoing investment linked to downstream metals. Malaysia’s economy is being lifted by the datacentre and semiconductor-adjacent capex cycle, which is boosting growth and stabilising the Ringgit despite softer China-linked trade. Thailand, by contrast, is still struggling to regain momentum, with tourism softer than expected and political uncertainty weighing on investment.

b. Latin America: from underdog to top dog

On a country level, some of the strongest rallies this year have demonstrated a point we make to investors consistently: that for EM markets which are cheap, prices can be sensitive to even small re-allocation decisions from global or even domestic investors. This has been the case in three of the top performers in EM this year: Colombia, Chile and Peru – up 108%, 58% and 51%, respectively in total return terms. At least half of the rally in each case has been due to the indices rerating from low levels. The rest of the rally has been made up of upwards revisions to earnings forecasts and strong FX gains. Mexico and Brazil, which make up the larger part of the MSCI LatAm index market cap, have also both had very good years for equity returns, up 49% and 48%, respectively. Both have seen some rerating and positive currency effects. Argentina has had a down year, but with President Javier Milei having won US financial backing and a very strong mandate to continue with his reform agenda in 2026, the outlook for Argentine assets next year is currently very positive. 

Even after posting very strong returns in 2025, LatAm is perhaps the region where we still see the clearest upside for equity outperformance across EM in 2026. While equity indices have rerated, they have done so from very undervalued levels and are still below historical averages in absolute and relative terms to the US. The MSCI LatAm index 12 months ago was trading around 9.5x forward earnings – today it is trading close to 10.5x. This still represents a near 50% discount to the SPX index, trading at 22x,  even though earnings growth for both is expected by Bloomberg consensus to be about the same, at 11% for the next three years. This alone should have  have investors’ attention. In addition to rerating momentum, the MSCI Latam currently carries a 5% dividend yield, vs just 1.2% for the S&P 500. This provides downside protection even in a de-rating scenario. 

The ongoing ‘blue wave’ in politics means there is a strong chance that most major South American economies will be under market-friendly administrations by the end of 2026, as per Fig. 12. This can be the key catalyst behind a lowering of risk premiums in the region, and therefore higher equity market valuations. For Mexico, enjoying political stability under Claudia Sheinbaum, renewing the USMCA trade agreement under favourable terms will be the key catalyst to watch for. 

c. CEEMEA: Hidden gems on smaller markets?

Within EMEA, we prefer South Africa over the GCC. Reforms, improving power stability and better fiscal discipline are helping underpin a gradual recovery, while higher metals prices provide a favourable terms-of-trade impulse. GCC performance remains steady, but the absence of an oil risk premium and continued IPO supply in Saudi Arabia limit relative equity upside.

7 | EM Debt: Investors taking notice after three consecutive years of outperformance

a. Better macro dynamics since COVID-19: higher GDP growth and lower inflation. 

We’ve been highlighting, for three years now, how resilient EM economies and markets have become in an environment where the DM macro environment has been uncertain. The fact that EM countries managed to achieve higher growth and lower inflation than expected since the pandemic has continued to drive market returns, even if flows have been lagging. 

b. Supportive of large number of net upgrades.

The more positive macro dynamics for EMs can be seen on a simple data point. Over the last two years, all three rating agencies have delivered upgrades to many more EM countries than downgrades, as per Fig. 13. 

1. See – https://www.gartner.com/en/newsroom/press-releases/2024-11-12-gartner-predicts-power-shortages-will-restrict-40-percent-of-ai-data-centers-by-20270