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Three things we are watching

Diversification: Emerging markets (EM) are likely to remain beneficiaries should investors continue to diversify their portfolios in the year ahead. Investor allocations to emerging markets remain below benchmark weights,1 especially with regard to Chinese equities. While this was the right strategy in prior years, that changed in 2025. We expect portfolio inflows to support EM markets, which have clear attractions. These include a broad range of companies with exposure to artificial intelligence (AI) supply chains, select large markets with low trade exposure (India and Brazil), and attractive valuations relative to developed markets.

India earnings recovery: Indian equities' potential to reverse their 2025 underperformance relative to other EMs is partially dependent on a recovery in earnings. Consensus expectations for the Nifty50 Index in the year ahead is 15% earnings growth.2 An expected recovery in consumption and government spending should help drive this growth. Low inflation is creating room for a reduction in interest rates, which would also be supportive of a recovery in earnings.

Latin America (Latam): The fallout from US actions in Venezuela is likely to have an impact on investor assessment of risk premia across developed and emerging markets over the long term. In the near term, lower oil prices and a continued easing of inflationary pressure are likely to maintain the trend of lower interest rates globally, excluding Japan. While Venezuela may dominate headlines related to Latam in 2026, Brazil’s presidential election, scheduled for October, should also be a focus for investors.

Outlook

We leave a strong 2025 behind us, as EM equities outperformed developed market (DM) equities.3 While expecting a repeat of such exceptional performance may be too optimistic, our outlook for EM equities in 2026 remains constructive. We base this outlook on several supportive themes that continue to drive earnings momentum across the asset class.

AI supply chain: EMs are far from homogeneous, and the diversity across countries and sectors creates distinct opportunity sets. AI will remain a key driver within the broader information technology space, and the structural growth potential of AI continues to underpin the investment case we foresee across key EM markets. Importantly, the opportunity set extends beyond the direct semiconductor beneficiaries in Taiwan and South Korea. We believe attractive exposure is also emerging along the AI supply chain—such as electronic manufacturing services, power supply units and printed circuit board companies.

In parallel, select China-based internet companies are increasingly embedding AI into their ecosystems, potentially leading to cost efficiencies as well as incremental growth on top of traditional e-commerce and advertising models. Leading Chinese internet names are major cloud service providers and should benefit from rising demand for AI-related workloads.

China’s industrial leadership: The global demand for power continues to rise, a trend which is accelerating amid the growing energy needs of data centers supporting the AI boom. This need has created a surge in demand for related infrastructure, including energy storage batteries and related power equipment. Chinese industrial companies are at the forefront of this trend, delivering growth in both their domestic market and, increasingly, through exports. Similarly, Chinese electric vehicle manufacturers are leveraging their technological advantages to gain international market share, a trend that appears likely to continue throughout 2026.

Policy shifts and domestic reforms: Many EM central banks have continued to ease monetary policy to support domestic demand and balance broader policy objectives, and we expect this trend to persist in 2026.

In China, the anti-involution campaign aims to curb excessive price competition and industrial overcapacity. While it is too early to gauge the success of this initiative, it may begin to shift incentives away from margin-destructive competition, particularly in sectors where policy scrutiny is rising. For well-managed companies, this could reduce the need for defensive spending to protect market share, with could then improve earnings quality and enable a more rational allocation of resources over time.

In India, consumption-focused policy support appears to be having an impact on recent consumption trends. In 2026, the benefits of these reforms should become more evident in corporate earnings.

In Latam, Brazil is well-positioned to benefit from a more accommodative interest-rate environment in 2026, although upcoming elections could introduce some market volatility. Mexico, meanwhile, continues to benefit from near-shoring dynamics and its strategic proximity to the United States.

Trade, tariffs and resilience: US tariffs have now largely come into place, as most countries have secured trade agreements. At the time of writing, some EM countries, including Brazil and India, remain in active trade talks with the United States. However, these economies are relatively less reliant on exports than some peers and are therefore somewhat more insulated from direct tariff shocks should they come to pass.4

EM equities have already demonstrated resilience by recovering from the initial tariff-related disruptions in 2025. We believe this adaptability—through supply-chain adjustments, trade rerouting and domestically anchored growth drivers—should continue to support the asset class.

Conclusion: We believe compelling long-term themes, shape the investment landscape for EMS in 2026, and these themes include leadership in AI-related supply chains, technology, digitalization, the premiumization of consumption and health care. These structural growth areas, combined with supportive valuations in select EMs, underpin our constructive outlook for 2026.

Market review: Fourth quarter 2025

EM equities rose in the final quarter of 2025. The US Federal Reserve made its last interest-rate reduction for the year in December and created an opportune environment for equities globally. For the quarter, the MSCI EM Index returned 4.78%, while the MSCI World Index delivered 3.20%.5

The emerging Asia region rose, with equity indexes in most countries advancing. Indian equities fared well this quarter, although the pace of outperformance weakened in December as investors locked in profits. Inflation continued to be tame, while the economy reported brisk growth of 8.2% in the second quarter of fiscal year 2026. South Korea’s equity market received support from its auto companies and its two largest semiconductor firms. The former came as the United States reduced its tariffs on auto imports and the latter on reports of plans to increase production. A global AI rally lent a helping hand to Taiwanese equities, pushing the nation’s equity index ahead. This AI exuberance helped Taiwan achieve its highest growth in export orders in nearly five years in November, as exports of telecommunications and technology products persisted.

Chinese equities came under pressure after the Politburo signaled a more restrained approach for its stimulus in 2026. Our China equity portfolio manager summed up the statement pretty succinctly—there was nothing new, but it was the shortest since 2017, with only 1,318 Chinese characters. Our portfolio manager interpreted this as an unhurried approach to change anything yet.

Equities in the emerging Europe, Middle East and Africa regions advanced as well, tracking the general trajectory of global equity markets. Volatility in oil prices resulted in a cautious energy outlook and exerted some pressure on Saudi Arabian equities. In South Africa, inflation slowed for the first time in three months in November, bolstering expectations that the central bank will reduce interest rates further in 2026 even with a lower inflation target.

Equities in the emerging LatAm region ascended, led by Chilean equities due to higher copper prices. Mexico’s central bank cut rates in December, easing its benchmark interest rate to 7%, its lowest level since June 2022. Brazil’s economy contracted in October from a month ago, a tell-tale sign that short-term activity is cooling under tight monetary policy.

Endnotes

  1. Sources: MSCI, JP Morgan. As of September 30, 2025.

  2. Source: Jefferies Equity Research and Strategy. As of December 12, 2025.

  3. Sources: FactSet and MSCI, for calendar year 2025. The MSCI EM Index return was 34.36% and the MSCI World Index return was 21.60%. Both returns are in US dollars.

  4. Source: World Bank 2024 exports as a % of GDP: India 21%; Brazil 18%.

  5. Sources: FactSet and MSCI.

Index Definitions

Past performance is not an indicator or a guarantee of future performance. Indexes are unmanaged and one cannot invest directly in an index. Important data provider notices and terms available at www.franklintempletondatasources.com

  1. The MSCI All Country World Index is a free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global developed and emerging markets. 
  2. The MSCI Brazil Index is designed to measure the performance of the large- and mid-cap segments of the Brazilian market.
  3. The MSCI China Index captures large- and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g., ADRs). 
  4. The MSCI EM Asia ex Japan Index captures large- and mid-cap representation across two of three developed markets (DM) countries (excluding Japan) and eight emerging markets (EM) countries. 
  5. The MSCI EM Latin America Index captures large- and mid-cap representation across five emerging markets (EM) countries in Latin America.
  6. The MSCI EM EMEA Index captures large- and mid-cap representation across 11 emerging markets (EM) countries in Europe, the Middle East and Africa (EMEA). 
  7. The MSCI EM Index is a free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global emerging markets. 
  8. The MSCI India Index is designed to measure the performance of the large- and mid-cap segments of the Indian market.
  9. The MSCI Mexico Index is designed to measure the performance of the large- and mid-cap segments of the Mexican market.
  10. The MSCI South Korea Index is designed to measure the performance of the large- and mid-cap segments of the South Korean market.
  11. The MSCI Turkey Index is designed to measure the performance of the large- and mid-cap segments of the Turkish market.
  12. The MSCI World Index captures large- and mid-cap representation across 23 developed market countries.


WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Equity securities are subject to price fluctuation and possible loss of principal.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.

The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.

There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.

WF: 8140911

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