Emerging Markets in a World Beyond US Exceptionalism

The early months of 2025 challenged the long-standing presumption of U.S. leadership in global equity markets, as markets responded to tariff shocks and renewed fiscal concerns, underscored by Moody’s downgrade of U.S. government debt, fears of fiscal expansion reflected in the latest U.S. budget and a spike in long-term bond yields above 5%.¹ The rise in Treasury yields was accompanied by a weaker USD, marking a break in the pattern of their historical correlation.² This turning point could indicate an end to historically high inflows into U.S. equity markets. Despite recent recovery, uncertainty around policy and rates remains. 

Meanwhile, the MSCI Emerging Markets Index outpaced broader universes, gaining 8.9% in USD year to date through May 30, versus 5.2% for the MSCI World Index and 1.1% for the MSCI USA Index.³ A 34% year-to-date rise in average daily volume of futures linked to the MSCI Emerging Markets Index, along with a rise in open interest, suggests increased investor interest in EM equities and tactical positioning amid heightened volatility. 

We examine EM equity investing by analyzing trends in valuations, economic exposure and foreign exchange (FX) as a guide for investors interested in allocating beyond the developed markets (DM). 

EM valuation discounts, rising credit quality and tariff-risk insulation 

As of May 30, 2025, U.S. equities were trading at over 21 times forward earnings, compared to 12 times for EM equities — one of the widest valuation spreads in the last two decades. A spread this wide suggests investors may find fertile ground in companies of EM countries that have gradually strengthened their fundamentals and are enjoying increasing macroeconomic stability.  

Data period from June 30, 2003, to May 30, 2025. EM is represented by the MSCI Emerging Markets Index, and US is represented by the MSCI USA Index. Relative valuation is based on the forward price-to-earnings ratio.


A key indicator of improving EM fundamentals has been the steady ratings’ rise of EM corporate bonds following the COVID-19 pandemic, possibly as some EM countries adopted more-measured policy responses than their DM counterparts. By early 2025, the average EM corporate-bond rating of USD-denominated debt reached the highest level in nearly 20 years, despite struggling against a strong USD.  

Data period from Dec. 31, 2006, to May 30, 2025. We plot the average credit rating for the constituents of the MSCI Emerging Markets Corporate and MSCI Developed Markets Corporate Indexes, calculated in USD. For more details on the methodology of the average credit ratings, please refer to the MSCI Fixed Income Index calculation methodology.

In addition to EM companies’ low valuations and improving credit ratings, their revenue sources are not heavily U.S. or China dependent. Using MSCI Economic Exposure data, we found that many EM companies generated a significant share of their revenue domestically or within other EM countries, creating a potential buffer to tariff uncertainty. Taiwan is a notable exception. As of May 30, 2025, the MSCI Taiwan Index had elevated U.S. revenue exposure from the significant index weight of the Taiwan Semiconductor Manufacturing Company and its globally diversified client base. 

Data as of May 30, 2025. In addition to the MSCI USA, MSCI World and MSCI Emerging Markets Indexes, we show the economic exposure of the top five regional markets in the MSCI Emerging Markets Index. Economic exposure at an index level was calculated as the constituent weight times the revenue exposure of the constituent. Economic exposure is measured in USD. More information is available in “Economic Exposure in Global Investing.” 

Low correlations highlight EM diversification potential 
Rolling six-month correlations between EM and DM equities have tended to decline in periods of stress. By the end of May 2025, the correlation fell below 0.45 — the second-lowest level in the last two-and-a-half decades and the lowest level in the last five years.⁴ The shift in this relationship suggests the forces that move prices in EM equities are distinct from those in DM. Consequently, EM equities could play an important role in broadening a portfolio’s diversification. 

Data period from Dec. 31, 1999, to May 30, 2025. We show the six-month rolling correlation between the weekly returns of the MSCI Emerging Markets and MSCI World Indexes over the last 25 years and over the last five years. We used the VIX Index as an indication of the volatility in the market over the period.  

Historically, FX has often battered the returns of international investors in EM. A strong USD has tended to raise the cost of USD-priced commodities, increased debt-servicing costs for EM issuers with USD liabilities and, in general, reduced the appeal of EM assets. 

We compared EM equity returns relative to DM returns in USD terms with the Nominal Broad U.S. Dollar Index.⁵ The two series have generally moved in opposite directions over the last 20 years. EM underperformed DM during periods of USD strength, such as in the 2011-2016 period and again after 2021, and outperformed when it weakened, such as in the 2009-2010 and 2016-2018 periods. If the macro situation in the U.S. were to improve and the USD strengthen, EM could face renewed headwinds.  

As of May 30, 2025, EM currency volatility, based on the MSCI EM Currency Index, was at a multi-decade low, consistent with stronger EM macroeconomic fundamentals, higher foreign-currency reserves and narrower deficits. The USD has weakened 5.5% year to date through May, based on the Nominal Broad U.S. Dollar Index, indicating a possible tailwind for EM returns.  

Data period from Jan. 01, 2006, to May 30, 2025. EM/World represents the relative performance of the MSCI Emerging Markets Index relative to the MSCI World Index. Source: Nominal Broad U.S. Dollar Index, FRED

Widening valuation gaps, stronger credit fundamentals and a lower reliance on U.S.-specific drivers have recently renewed global equity investors’ interest in EM. As U.S. leadership in global equity markets begins to wane, regional and asset-class distinctions are taking on more importance. The increased open interest in EM futures contracts since the beginning of January 2025 indicates this change in focus.⁶

Nevertheless, structural and cyclical challenges persist for investors in EM equities. Country-level risks continue to cause performance dispersion, and although credit quality has improved, average bond ratings still lag those of DM. EM equities remain sensitive to external conditions, including U.S. trade policy shifts, slowing global growth and currency dynamics. The winds may be shifting, but clouds linger on the horizon.