Emerging market stocks and bonds are both surging; the last time they were this strong was in 2009, after the financial crisis.

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Driven by a weakening US dollar, attractive valuations, and the artificial intelligence boom, emerging market assets are experiencing a strong rebound, with their stock market performance posting the best start since 2009. This broad-based rally marks the powerful return of emerging markets to the global investor spotlight after more than a decade of stagnation.

So far this year, the MSCI benchmark index tracking emerging market stocks has soared 28%, the largest gain for the same period since the post-global financial crisis recovery in 2009. This performance far exceeds that of developed economies, whose MSCI index has risen less than 17% over the same period.

The bond market has also performed impressively. A JPMorgan index tracking local-currency government bonds in developing countries is up 16%, the biggest surge since 2016. Expectations of Federal Reserve rate cuts, coupled with high yields in emerging markets themselves, are attracting large amounts of return-seeking capital.

Analysts believe that after fifteen years of mediocre performance, “favorable factors are finally coming together.” Ian Simmons, Senior Portfolio Manager at Fiera Capital, points out that the weaker dollar is “the most important variable,” paving the way for the strong comeback of emerging market assets and indicating that investors may be reassessing the long-standing US-dominated market landscape.

A Weaker Dollar as the Key Driver

A weak US dollar exchange rate usually improves the financial environment for developing countries by lowering the cost of repaying US dollar-denominated debt. Ian Simmons says that whether “deliberately or inadvertently,” US President Trump seems indeed to have facilitated a weaker dollar.

Expectations of Fed rate cuts have also infused the market with momentum, supporting investors’ arbitrage trades—financing with dollars and investing in high-yielding local currency bonds. Damien Buchet, Chief Investment Officer at Principal Finisterre, notes that about half of the return of the JPMorgan local currency bond index this year has come from currency appreciation. He adds, “Central banks are in easing mode, and the dollar continues to trend weaker.”

AI Boom Resonates with High Yields

In addition to favorable macro factors, two major investment themes are also providing solid support to the rally in emerging markets: artificial intelligence and high yields.

In the stock market, the global AI frenzy is spreading to emerging markets that dominate chip manufacturing. South Korea’s Kospi index and Taiwan’s Taiex index have both hit record highs in recent days, as investors pile into manufacturers of chips, electrical equipment, and other essentials for AI data centers. TSMC, the world’s largest chipmaker, has seen its market value surge, accounting for as much as 11% of the MSCI emerging markets benchmark index.

In the bond market, high real yields are the main draw for investors. Central banks in larger emerging markets like Brazil and South Africa have remained cautious in cutting rates, while more fiscally fragile countries like Turkey are maintaining double-digit rates to attract capital. Even in Asian economies with lower rates, such as Thailand and Malaysia, easing inflation has kept local-currency bonds attractive to domestic investors. According to S&P Global Ratings, to meet investor demand for high yields, the local-currency sovereign bond issuance of 17 major emerging markets (excluding China) has hit a record $286 billion this year.

Valuation Gaps Remain Attractive

Despite the rally, emerging market equity valuations remain far below those of US stocks, leaving room for further gains. Much of this year’s rally has been driven by “valuation repair,” i.e., an increase in the ratio of share prices to expected earnings.

Currently, the forward price-earnings ratio of stocks in the MSCI emerging markets benchmark is about 14, compared to about 23 for the S&P 500. Vivian Lin Thurston, portfolio manager at William Blair, says, “There is a huge valuation gap between the US and the rest of the world, and this gap remains significant.”

By contrast, Indian stocks have become a notable laggard in this emerging market rally, partly because their prices were already pushed to expensive levels similar to US stocks, while corporate earnings have failed to meet expectations. One fund manager states that renewed interest in emerging markets also reflects “the twilight of US exceptionalism,” as the US’s own instability and erratic policymaking make it “behave more and more like an emerging market,” prompting investors to look elsewhere.

Capital Allocation Still Lags

It is worth noting that, despite the strong performance of emerging market assets, global capital allocation overall still appears to lag behind the rebound.

Fiera Capital’s Simmons points out that emerging market assets “currently hold a very low proportion and allocation level in portfolios.” This signals that if more investors follow the trend and shift capital from developed markets to emerging markets, there could still be considerable upside potential in this rally.

Moreover, the breadth of this rally is noteworthy. It has continued even as Argentina—a typical emerging market trading subject, now largely out of the global investor spotlight—brews another debt crisis, showing that current interest in emerging markets is broad-based rather than local.

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