Emerging markets said to see the next bull run as the ‘sell U.S.’ narrative gains ground

Emerging markets stocks are in the spotlight again as the “sell U.S.” narrative gained fresh momentum, following Moody’s recent downgrade of the U.S. credit rating.

The Bank of America heralded emerging markets as “the next bull market” recently. 

“Weaker U.S. dollar, U.S. bond yield top, China economic recovery…nothing will work better than emerging market stocks,” Bank of America’s team, led by investment strategist Michael Hartnett, said in a note. 

Similarly, JPMorgan upgraded emerging market equities from neutral to overweight on Monday, citing thawing U.S.-China trade tensions and attractive valuations.

A dented confidence in U.S. assets, which kicked into high gear last month marked by a selloff in U.S. Treasurys, equities and greenback, has fueled the bullishness for emerging markets.

The MSCI Emerging Markets Index, which tracks large and mid-cap representation across 24 EM countries, is up 8.55% year-to-date. This compares against a 1% climb by the U.S. benchmark S&P 500 across the same period.

The difference was more stark in the weeks after April 2, when U.S. President Donald Trump unveiled “reciprocal” tariffs on friends and foes alike. 

While most benchmarks fell across the board in the immediate days after April 2, the week that followed showed a divergence between emerging market equities and U.S. stocks. Between April 9 to 21, the S&P 500 declined over 5%, while the MSCI Emerging Markets Index rose 7%.

Even though U.S. equities and Treasurys rebounded slightly since, the recent Moody’s downgrade has reignited traders’ concerns. On Monday, the U.S. 30-year Treasury yield briefly grazed above 5% to hit levels not seen since November 2023, while U.S.  equities also snapped a six-day winning streak on Tuesday.

The events that unfolded recently have reinforced the need for more diverse geographical exposure, said Malcolm Dorson, head of the active investment team at Global X ETFs.

“After underperforming the S&P over the past decade, EM equities are uniquely positioned to outperform over the next cycle,” he added.

“This possible perfect storm stems from a potentially weaker U.S. dollar, extremely low investor positioning, and outsized growth at discounted valuations,” he told CNBC.

According to data provided by Dorson, in terms of positioning, many U.S. investors have just 3% to 5% in emerging markets, compared to the 10.5% in the MSCI Global Index, which captures the performance of large and mid-cap companies across 23 developed markets.

Emerging markets are also trading at 12 times forward earnings “and at a bigger than typical discount” compared to developed markets, statistics from JPMorgan showed.

Among emerging markets, Dorson believes India offers the best long–term growth play and spotlighted Argentina’s cheap valuation. Sovereign upgrades in countries like Greece and Brazil also helped to make them more attractive, he added.

“We could be at the start of a new rotation,” said Mohit Mirpuri, equity fund manager at SGMC Capital.

“After years of U.S. outperformance, global investors are beginning to look elsewhere for diversification and long-term returns, and emerging markets are firmly back in the conversation,” Mirpuri said.

A weakening U.S. dollar — pressured by fiscal concerns and rising debt — has historically supported EM flows and FX stability, said a portfolio manager at VanEck, Ola El-Shawarby.

But what could set the current optimism apart from previous emerging market rallies that fizzled out?

“We’ve seen EM rallies before that ultimately lost steam, often because they were driven by short-term macro catalysts,” said El-Shawarby.

This current cycle could be different because of the combination of deeply discounted valuations, historically low investor positioning, and more durable structural progress across key markets, she said, citing India’s long-term growth story anchored in domestic demand.