Damien Hennessy
Emerging Asian economies are highly dependent on imported oil, particularly through the Strait of Hormuz, so it is not surprising that these equity markets have come under pressure over the past two weeks, says Zenith Investment Partners investment director, Damien Hennessy.
Higher oil prices and the prospect of higher inflation suggest that hopes for near term rate cuts have faded, he says, and along with a stronger USD, this has undermined emerging market equities during March.
“Our view remains that emerging market equities are set to climb in 2026 driven by an improving global cycle, improved external and internal balance sheets, a modestly weaker USD and more attractive valuations compared to developed markets,” says Hennessy.
“Emerging markets have lagged developed markets since 2021. It’s been one-way traffic in favour of the United States.
“But that has shifted over the past 12 months, as investors reconsider high valuations in US equities and rotate towards cheaper opportunities across Asia and other developing economies. The USD has fallen by around 10 per cent over the past 12 months, which is a historical indicator of positive emerging market performance,” he says.
While the softer dollar has helped support US corporate earnings and share prices despite stretched valuations, Hennessy says that the opportunity now lies outside the US.
“There’s no doubt that the weaker US dollar has played a central role in the broad shift away from expensive US technology and AI stocks, toward more attractively priced AI exposures across Asia, particularly China.
“In South Korea, a couple of AI-related stocks have dominated performance although corporate reforms have also helped drive a re-rating. The market’s price-to-earnings ratio has lifted from below 8 times earnings to around 10 times today.”
In addition to more attractive valuations, Hennessy says emerging market balance sheets are in stronger shape than many developed economies, while government debt as a proportion of GDP is generally lower compared to some major global economies.
Inflation trends have also improved, with several emerging economies able to bring inflation under control and begin cutting interest rates, which has supported domestic growth and equity markets. An extended conflict in the Middle East would alter that outcome.
“There’s a combination of factors that have helped drive equities performance in emerging markets, and we believe the improvements we saw last year broadly remain in place,” Hennessy says.
“While the near term will be challenging, from a strategic asset allocation perspective, we’ve increased exposure to the asset class as it offers relative value, earnings potential and better quality than it has for many years.”