(PWM) - For more than a decade, emerging markets have lived under the shadow of two persistent narratives. The first is that innovation comes from the developed world and only diffuses outward. The second is that EM returns are hostage to currency swings, global rate cycles, and episodic political disruption. Yet the underlying composition of the asset class has changed significantly.
A closer look at the fundamental drivers of today’s emerging markets shows a landscape that has shifted from commodity sensitivity to world-class businesses. Earnings growth is accelerating across regions. Valuations remain deeply discounted. Capital flows are only beginning to recover from a historic period of under allocation.
The case for emerging markets cannot be reduced to a single catalyst. It sits at the intersection of innovation leadership, attractive pricing and a structural supply of future potential inflows.
Inflation had already eased across many EM economies while central banks in the US, Canada and Europe were still deciding when to act. Currencies were steadier, rate cuts were already underway, and a softer dollar only amplified the advantages. But the real story is not what happened in the rearview mirror, it is what these conditions reveal about where the next leg of global growth may be forming.
The strength of this evolving emerging market landscape was evident in the first quarter of 2026. Performance was supported by strong gains in January and February, driven b(y artificial intelligence-related momentum, before reversing in March as escalating geopolitical tensions and rising energy prices triggered a broad-based risk-off environment.
The emerging Asia region rose slightly, as domestic strength in several countries managed to dilute global pressures from a burgeoning conflict in the Middle East. South Korean and Taiwanese equities were strong performers as the AI theme continued to gain traction. Indian equities fell on rising oil prices, spurring concerns that a prolonged environment of higher oil prices could lead to higher inflation, fiscal deficit and squeeze on corporate margins.
The ongoing war in the Middle East has significantly disrupted Europe, the Middle East and Africa regions, pushed oil prices higher, and raised the broader economic risk premium attached to Middle Eastern assets.
At the same time, Saudi Arabia has held up relatively better, spared the worst of the direct conflict and its economy benefits more from sustained higher oil prices. Equities in the United Arab Emirates, in particular, were among the weakest performers in the region.
Tensions in the Middle East seem to have de-escalated with the announcement of a two-week ceasefire. However, this is a near-term de-escalation rather than a resolution, and underlying issues remain unresolved with the situation still fragile. There could be longer-term implications for the UAE, particularly through weaker business confidence and potential delays in investment recovery.
Innovation elation
The most overlooked story in emerging markets investing is the rise of innovation as a structural driver. Asia now accounts for more than half of global patent grants.
The semiconductor supply chain is dominated by emerging market firms such as Taiwan Semiconductor Manufacturing Company, Samsung and SK Hynix, companies that sit at the centre of the technologies powering AI, cloud computing and advanced electronics.
“The most overlooked story in emerging markets investing is the rise of innovation as a structural driver. Asia now accounts for more than half of global patent grants”
The electric vehicle and clean energy sectors show a similar pattern. China and Korea lead the world in EV battery production. Companies like BYD continue to scale rapidly across Europe, moving from niche competitors to mainstream manufacturers with global footprints.
Digital infrastructure tells another part of the story. India’s biometric identification system, which covers roughly 95 per cent of the population, has enabled seamless access to bank accounts, payments and brokerage platforms. This single development has transformed the country’s savings and investment behaviour.
Other regions across Latin America and Asia are moving along similar paths. Companies like Cognizant, though listed in the US, derive much of their talent and operational strength from India. These types of firms can fall outside traditional EM indices, yet they represent the global, services-oriented businesses driven by highly skilled emerging market workers.
This transition matters because it broadens the base of EM earnings beyond commodities. Profitability is now driven by domestic consumption and world-class global businesses. The result is a stronger, more resilient foundation that behaves differently than the emerging markets of 10 or 15 years ago.
Valuation gap
Even after a strong year, EM equities remain deeply discounted relative to developed markets, in particular the US.
On a price-to-earnings basis, emerging markets trade at roughly a 38 to 39 per cent discount to the S&P 500. The 10-year average sits closer to 29 per cent. Based on 2026 earnings expectations, the gap widens to more than 40 per cent.
Currency dynamics also look more favourable than they have in years. The US dollar has been range-bound, which can reduce the currency impact on EM returns. Meanwhile, emerging markets have been cutting interest rates more slowly than developed economies, a trend that supports currency stability and preserves real yield advantages.
The valuation argument is straightforward. Emerging markets investing offers higher earnings growth at a lower price. If the earnings picture holds and policy signals remain supportive, the discount has room to compress.
Structural allocation
Fifteen years ago, global investors held roughly 13.5 per cent of their equity exposure in EM. Today, that figure is near 5 per cent. The 10-year average sits around 6.7 per cent. A return to even that midpoint would require hundreds of billions of dollars in inflows.
Many investors underestimate how narrow their EM exposure actually is when they rely on global mandates. Global equity portfolios might hold EM megacaps like TSMC.
What might be missing are the ecommerce platforms selling to young, educated emerging consumers in large, populous countries like China, India, Brazil and Indonesia; the renewable energy supply chain leaders across China helping to decarbonise the world; or opportunities in the Middle East, where wealthy economies are meeting structural reforms.
In 2026, the alignment of key forces is clear. Earnings expectations outpace those of developed markets, valuations remain discounted, currency conditions are stable, policy environments across EM continue to support growth and capital flows are slowly stabilising.
The outlook for EM equities reflects a mix of improving earnings trends and ongoing geopolitical and structural risks, leading to a more selective opportunity set. Geopolitics and domestic political cycles continue to influence capital flows, commodities and sentiment, while growth remains uneven across regions and sectors.
“The outlook for EM equities reflects a mix of improving earnings trends and ongoing geopolitical and structural risks, leading to a more selective opportunity set”
Geopolitical considerations require active monitoring across multiple channels. The situation in the Middle East remains fragile despite near term de-escalation efforts.
Historical structural underweights in the region reflect its economic sensitivity to oil prices and global growth dynamics, and ongoing tensions warrant continued caution. However, these regional challenges do not diminish the broader structural case for emerging markets as an asset class. Emerging markets remain compelling for investors with a medium to long-term horizon.
By Andrew Ness
May 1, 2026
