Pessimists become extinct! Emerging market securities achieve their best performance in 16 years, Wall Street bets on the start of the "capital inflow supercycle".

Emerging markets are poised to become Wall Street's darlings at the start of 2026, as asset management firms are betting on a sustained multi-year cycle of capital inflows that has already begun. The scale of capital inflows into the sector this year - covering all emerging market securities and achieving the best performance since 2009 - indicates that more and more investors are reallocating to this asset class that has been lackluster and long overlooked for years. Since 2017, emerging market stocks have outperformed U.S. stocks for the first time, the yield spread between emerging market bonds and U.S. treasuries has narrowed to the lowest level in 11 years, and arbitrage trading strategies - typically borrowing low-yield assets to buy high-yield assets - have also achieved the best returns since 2009. Bank of America recently held an investment conference in London that fully showcased the market's enthusiasm for the sector. The bank invited 300 investors and held 170 meetings, finding that almost no one held a pessimistic view towards emerging markets. David Hauner, head of emerging market fixed income at Bank of America, concluded, "Pessimists on emerging markets have vanished." A fundamental shift in global capital flows may be underway. Portfolio managers are eager to diversify away from the U.S., while also increasingly attracted to the progress that developing countries have made in debt reduction and inflation control. This is an almost unforeseen reversal. Until recently, investors had avoided the emerging market asset class due to weak returns over the years and concerns about the U.S.-China trade war. Fund managers found it difficult to recommend emerging markets to clients, while hedge funds indicated that their best opportunities were in shorting emerging markets. Sammy Suzuki, head of emerging market equities at AllianceBernstein LP, stated, "2025 was a turning point. A year ago, the question was whether emerging markets were worth investing in, but now we are no longer asked that question." More upside potential Banks such as JPMorgan and Morgan Stanley have also joined the bullish camp, predicting that emerging markets will benefit from a weak dollar and investment boom in the artificial intelligence sector. JPMorgan forecasts that emerging market bond funds will see inflows of up to $50 billion next year. Bob Michele, head of global fixed income at JPMorgan Asset Management, stated, "One of our best investment strategies remains holding local currency bonds in emerging markets. We should see some price appreciation, we can earn yield spreads, and we believe there is still some upside potential in emerging market currencies." Morgan Stanley also recommends clients hold local currency bonds and increase exposure to U.S.-dollar-denominated emerging market bonds. Bank of America expects that hard currency emerging market bonds will replicate this year's double-digit returns. One key driver may be the positioning. Despite the rebound, the scale of capital inflows so far has been relatively small. Strategas Securities estimates that nearly $31 billion has flowed into U.S. ETFs focused on emerging market stocks in 2025. According to EPFR Global data compiled by Bank of America, emerging market bond funds have absorbed over $60 billion, but this comes after outflows of $142 billion in the previous three years. This means that the allocation of emerging markets in global investment portfolios is still below par. Todd Sohn, senior ETF and technical strategist at Strategas, commented that this year marks a "return of asset allocators" after enduring a tough five years. He said, "Many people realize that they are overexposed to U.S. large-cap growth stocks, so they are shifting towards a globally diversified allocation." Meanwhile, the share of emerging markets in global stock and bond benchmark indices is rising. In the Bloomberg Global Mid-Cap Index, the weighting of emerging market stocks has increased by over one percentage point relative to developed markets, reaching nearly 13%, while the allocation of emerging market bonds in the Bloomberg Global Aggregate Total Return Index has also increased. Rajeev De Mello of Gama Asset Management stated that investors are finally re-engaging with emerging markets, but he believes there is still room to "move towards a more meaningful overweight direction." The issue of the dollar The rebound of emerging markets this year may mask some vulnerabilities in this asset class, but the biggest test comes from the dollar. The dollar's 8% decline this year has supported emerging market assets, but many believe that if the Fed cuts rates less than expected, the dollar could rebound. Strategists at Citigroup advised clients to only buy emerging market assets that can withstand a strong dollar. Nevertheless, Citigroup still expects that emerging market bonds will achieve a total return of 5% next year. Bob Michele continues to be bullish on emerging market debt. Even in the scenario of a strengthening dollar, he expects that the "very high" real yields will continue to attract investors. Currently, funds continue to flow in. In the week ending December 17, emerging market bond funds attracted $4 billion, marking the largest single-week inflow since July. Sammy Suzuki stated that if emerging markets can withstand the tests of the dollar and Federal Reserve policy changes, cautious investors may believe that a structural asset reallocation is indeed taking place. He said, "This uncertainty provides investors with an entry point. Once everyone believes in this trend, it may already be too late."