Executive Summary

Emerging markets continue to benefit from strong earnings momentum, improving macro conditions and structural investment themes, despite recent geopolitical volatility. In the discussion, Justin Kariya, Head of Economic and Market Strategy at City of London Investment Management (CLIM), argues that the recent rally in emerging market equities has been driven primarily by earnings growth rather than valuation expansion, leaving room for further re-rating if earnings remain resilient.

A key focus of the interview is the growing importance of AI-related investment across emerging Asia, particularly in semiconductor and technology supply chains in Taiwan and South Korea. Kariya also highlights the potential impact of a weaker US dollar, shifting global trade patterns and energy diversification trends as supportive factors for emerging markets. While geopolitical risks remain elevated, particularly around China and energy markets, active management remains essential to identify structural growth opportunities while navigating country-level dispersion and volatility.

Transcript

Thomas Schalow: Hello everybody, and welcome back. Today I’m joined by Justin Kariya, Head of Economic and Market Strategy at City of London Investment Management. We will discuss the outlook for emerging markets in 2026, from the US dollar and earnings momentum to AI-related investments, geopolitics, energy price risks and country level dispersion. Justin, thank you very much for joining us today.

Justin Kariya: Thank you for having me.

Thomas Schalow: Justin, after a very strong year for emerging markets in 2025 and the recent geopolitical shock around the Middle East, where do you think emerging market equities stand today? Closer to the beginning of a broader re-rating or already largely priced at?

Justin Kariya: Well, I mean EM has had a very strong run this year and also last year. So I mean naturally investors sort of question exactly as you’re asking whether or not we’re kind of early mid or late cycle. And I think it’s very easy after such strong gains to kind of come to the conclusion that maybe the best returns are behind us. But I would just point out that a lot of the rally that we’ve seen over the past year is driven by earnings growth. Actually if you look at the forward P/E multiples, they’ve actually derated in emerging markets or at least relative to ACWI.

So if you dig a little bit further into that, if you look at consensus earnings projections for emerging markets relative to other major economies or stock indices rather, EM earnings growth is still very strong and higher than the rest of the world over the next year and it’s still trading at a very low forward pe. So I guess the kind of main takeaway from that is if EM or emerging markets rather continue to produce relatively robust earnings growth beyond this year, then there’s certainly scope for the market to re-rate.

Thomas Schalow: As you mentioned, emerging markets still trade at a significant valuation discount to developed markets even though earnings expectations have improved. Why is the discount still there, and what needs to happen for investors to assign a higher multiple to emerging market equities?

Justin Kariya: So I mean, the first thing I would point out — and particularly for younger investors, I mean I’m not that old, but if you’re under the age of maybe 40 — you probably don’t remember that EM used to trade at very similar valuations to other developed markets and the U.S., if you look prior to 2013. I think it’s a very good question in terms of why that discount has been so persistent over the past 15 years or so. And I guess there are probably various explanations.

But I guess the ones that come to mind for me are, first, I think there’s general frustration from asset allocators and investors following long periods of underperformance in emerging markets over that 2011–2024 period, particularly relative to the U.S. if you’re a U.S. allocator. And on that point, just to dig into it further, U.S. returns have obviously been very strong relative to international stocks more broadly, not just EM. So I think it’s natural for U.S. investors to think: why would I look elsewhere in my portfolio when you’ve had such strong returns from the Magnificent 7, for example, or the FAANGs before the Magnificent 7?

And I guess one thing to add to that is that, while EM earnings have certainly improved, as I mentioned previously, and that’s making the investment case more compelling, I think there’s still some skepticism around the sustainability of that earnings growth in emerging markets. A lot of it has been driven by artificial intelligence more recently. And it’s very difficult, I think, for many investors who aren’t necessarily tech experts to forecast AI demand in the future and the potential opportunities that could emerge from it.

The dollar trend is also quite important for emerging markets and, as I mentioned, for people our age, most careers have been dominated by a much stronger US dollar. So if we’re entering a period of dollar weakness, how do you shift your mindset, and what does that imply for emerging markets?

Thomas Schalow: So this leads directly into the next question. The US dollar has been one of the most important variables for emerging markets for many years. What is your base case for the dollar from here, and which emerging market regions would benefit most if dollar weakness continues?

Justin Kariya: So I mean, first out of the gate, I’ll just say that our house view is that we expect the US dollar to weaken over the course of the year. And historically, that has been a major tailwind for emerging markets, given that EM tends to have a strong negative correlation to the US dollar over long periods of time for various reasons.

I think one pushback to that view is that people will point out the dollar is the world’s reserve currency and will probably remain so for the foreseeable future. And I 100% agree with that statement. I think there is a lack of viable alternatives to really displace the dollar from that status.

But I would also point out that this does not exclude the possibility of periods of material dollar depreciation, even while it remains the world’s reserve currency. You can look at the early 2000s — the dollar experienced double-digit depreciation in trade-weighted terms, and it was still the world’s reserve currency during what was arguably peak US hegemony. So you can still have periods of dollar weakness even with it retaining reserve currency status.

And we think that’s really driven by a combination of valuation, cyclical and structural factors. The dollar still looks expensive on many valuation metrics, which is not a great starting point if you’re a buyer of dollars. Typically, people look at real rate differentials as a metric for where the dollar trend may be heading. And we would just note that when we plot U.S. real rates relative to other major economies, the trend does appear to be pointing lower for the US dollar.

And maybe a third point on the structural side: we do think there is going to be greater demand for diversification away from US dollars, particularly as we move into a more multipolar world.

And maybe just a fourth, more short-term point: the dollar briefly rallied in March as we were at peak geopolitical fears, but it has since reversed. And I think that’s quite interesting. It may suggest that the dollar is becoming a less reliable safe haven than it has historically been. So I think there is a good case that the dollar can potentially weaken from here.

I guess you asked which markets would benefit from that. I would maybe reframe the question slightly and instead ask which emerging markets would benefit less, because EM as an asset class does tend to broadly benefit from a weaker dollar environment. But I would note that, when we look at our country allocations, many of the Gulf countries, or GCC countries, are managed against or pegged to the US dollar. So they do tend to underperform in a weaker dollar environment relative to other emerging markets.

Thomas Schalow: Makes sense. You already mentioned the magic word “AI”. AI is often discussed as a US technology story, but much of the hardware supply chain actually sits in emerging Asia. So is AI capex now becoming a genuine emerging markets macro theme?

Justin Kariya: Yeah, I definitely think that, as an EM investor, you really cannot ignore what’s going on with capex trends in the US, particularly from the major US hyperscalers. This is probably — or arguably — the biggest tailwind for EM right now: the scale of spending from these US hyperscalers.

They’re spending hundreds of billions on semiconductors and chips, and maybe that will become trillions at some point on an annual basis. And they really seem relatively insensitive to energy costs or other macro factors for various reasons. They have their own reasons for making these large investments, whether that’s defending their competitive moats or remaining at the leading edge of AI.

And I guess the takeaway for EM investors is that this is effectively direct revenue flowing into some key EM technology markets — particularly technology manufacturing. South Korea and Taiwan stand out as two markets that have been major beneficiaries of this trend. And even as we’ve seen oil prices move above $100 in recent months, these EM tech-related markets have continued to outperform, driven by strong earnings growth and improving expectations, as I highlighted earlier.

Thomas Schalow: So you already mentioned the concentration in South Korea and Taiwan, which remain central beneficiaries of the AI hardware cycle. How do you balance strong earnings momentum in semiconductors and memory chips against valuation risks, geopolitical risks and the concentration of emerging market performance in a small number of companies?

Justin Kariya: So yeah, I mean, I think you’ve rightly pointed out that there are risks. First of all, there’s the risk that this AI-driven demand cycle will not last forever and will eventually slow at some point in time. And there’s also concentration risk, which is something US investors have had to deal with as well. So all of these things create challenges.

I guess the way we would look at it is that investors cannot simply ignore the strength in this area and decide not to invest, given the scale of revenues some of these companies are generating and how essential they are to the global AI and semiconductor supply chain. And that demand may persist for years — it’s not necessarily something that ends tomorrow. It could, but that’s not currently our base case. And the capex numbers are still coming in relatively strong.

I think the way a good EM portfolio manager should manage these risks — while also taking advantage of the opportunities — is by maintaining exposure to some of these key growth areas, while also thinking about where the next opportunities may emerge and gradually building exposure to future themes, whether within EM or in global markets more broadly.

For example, commodities may become increasingly important in the build-out of energy infrastructure, and EM certainly offers exposure in that area. And right now, we are still in the current “picks-and-shovels” phase of AI, where the focus is on training models and building hardware. But the next stage will be the application layer of AI.

How are we actually going to use this technology? Areas such as robotics, defence and military spending, AI productivity agents and broader real-economy AI applications are likely to become increasingly important. And EM does offer exposure to some of those areas as well — particularly in China, which we see as a potentially interesting investment area.

Thomas Schalow: China is a great keyword. China remains one of the most debated markets in EM. You differentiate between China A-shares and offshore Chinese equities. What is the rationale behind that distinction, and what would need to change for you to become more constructive on offshore China?

Justin Kariya: Since 2021, I think it was, China has been a pretty unloved market among foreign investors. And we certainly think there is potential there. We’re cautiously optimistic about the market.

I think there is always a risk when investors broadly avoid an entire market that they may end up missing attractive opportunities, even though there are clearly risks associated with it.

To give a few examples of interesting growth areas in China: renewable energy was arguably out of favour maybe three months ago, but now, as investors increasingly focus on energy diversification, it has suddenly become an important investment theme again — and China is a clear leader in that area.

I also mentioned the application layer of AI. China is certainly at the forefront of areas such as robotics and large language models, potentially at a lower cost base than some of the leading US models. So there may be competitive advantages there as well.

And similarly with electric vehicles: a few months ago, it seemed like that trend was fading, but now EVs are once again attracting strong investor interest — and China remains at the forefront of that market too.

So I’m simply making the case that there are several areas where China could become increasingly interesting from an investment perspective and could capture some of the most important structural themes globally, either as a leader or as a competitor to the US in the future.

That said, there are obviously clear geopolitical risks associated with China, which is one reason many investors have avoided the market.

It’s no secret that the US government — and Western governments more broadly — tend to shift between more supportive and more confrontational positions towards China over time. That’s one reason why we have tended to prefer A-shares, given that they are primarily domestically owned and therefore potentially less exposed to foreign capital outflows due to their large domestic investor base.

I would also add that we are seeing evidence that policymakers in China are attempting to redirect a large pool of domestic savings into the equity market. And potentially, A-shares could benefit from that trend.

But in terms of what could change our view and make us more constructive on offshore Chinese equities, I would note that any improvement in US-China relations could certainly become an important catalyst for offshore stocks.

Thomas Schalow: The Strait of Hormuz situation has brought energy dependence back into focus. How do you assess the impact of higher oil prices across emerging markets — both in terms of countries that are vulnerable and those that could eventually benefit from energy supply diversification?

Justin Kariya: Yeah, I mean, that’s certainly one of the main topics on investors’ minds right now. I would say first and foremost that one thing we really try to focus on is identifying the key long-term themes and not getting too bogged down in short-term noise.

So going back to the AI theme, I think this remains a very important investment trend that is likely to stay relevant over the next three to five years, potentially even longer. Even throughout this recent conflict and the oil shock, we’ve remained very focused on identifying which areas of emerging markets — particularly within the technology space — are likely to benefit from that trend. And so far, that approach has worked relatively well. As I mentioned, some of those names have continued to perform well despite the rise in oil prices.

But having said that, we obviously also need to focus on the macro risks. If the Strait of Hormuz were to close and oil prices moved significantly higher, that would clearly be a major shock. So we do try to identify countries that are most vulnerable to higher oil prices and perhaps lack strong structural growth drivers or sufficient buffers to absorb those shocks. That absolutely influences our allocation decisions.

And beyond the short-term volatility in oil prices — because they could move either higher or lower from here — I think one important long-term theme is energy diversification and the effort by countries to secure supply chains and reduce exposure to geopolitical choke points.

So Latin America, for example, is potentially an interesting area because it has become a more geopolitically secure source of commodities, particularly given its proximity to the US. I also mentioned Chinese renewables, which could potentially become more valuable in this environment. And Korea is home to several important battery manufacturers.

So I think there are opportunities emerging from both the current energy shock and the previous shock linked to the Russia-Ukraine conflict.

Thomas Schalow: Global trade is being reconfigured, with Mexico, Vietnam and parts of ASEAN benefiting from supply chain diversification. How durable is this friend-shoring trend? I also remember the “China+1” supply chain strategy. And what are the key risks from tariffs and potentially renewed trade tensions for emerging markets?

Justin Kariya: Yes, our view is that this friend-shoring trend, or broader supply chain readjustment, is an important long-term theme. And we think it is particularly relevant for certain emerging markets such as Mexico and Vietnam, just to name a few.

I think the real driver behind this shift is the US desire to reduce trade exposure to China, given how economically integrated the US and China have historically been. Policymakers are increasingly trying to diversify that economic relationship.

And as that process has evolved — which I would argue really began during Trump’s first term in 2016 — there have been some clear beneficiaries of that shift, and we think those trends can potentially continue. Vietnam is one example that we have highlighted within our allocations.

US politics can shift and tariff policies can change, of course. But we see this as a longer-term structural theme rather than a short-term trading theme.

Ultimately, I think the key point is that the US wants to reduce economic exposure to China — maybe not completely, but certainly to manage and diversify that exposure more actively. At the same time, the US economy still requires access to competitively priced manufactured goods.

Thomas Schalow: Let’s look at the other side of the world. Latin America’s political landscape has shifted meaningfully in recent years, with several countries moving towards more market-friendly agendas. Does this change the structural case for the region? And how do you differentiate between Mexico, Chile and Brazil?

Justin Kariya: Yeah, as your question highlights, several countries have gone through elections and have either moved closer — or are potentially moving closer — in their relationship with the US. And we think that creates a number of potential benefits for some of these economies.

This transcript was generated using AI and has been reviewed for accuracy.