Strong recent returns and a long-term case for portfolio diversification
Emerging market stocks were up sharply last year, and they’re continuing to do well in 2026. This often underappreciated asset class could play an important role in portfolio diversification for goals-based investors.
On the heels of a 30.6% return in 2025, the MSCI Emerging Markets Index (representing shares of companies in developing nations such as China, India, and Brazil) is off to its best start to a calendar year versus the S&P 500 index in three decades—outpacing domestic stocks by 14.4% through February (see the chart). Not surprisingly, that outperformance has faltered in recent days, with emerging market stocks lagging the S&P 500 by more than 4% since March 1 amid the bombing of Iran, which is driving investors away from riskier areas of the market.
Geopolitical shocks often trigger short-term risk-off sentiment, particularly in cyclical regions, but can create opportunities if the long-term investment thesis remains intact. Over time, emerging markets are likely to be supported by strong demand for AI-related technology from companies in Taiwan, South Korea, and other emerging economies, alongside rising fiscal deficits in developed countries and a weaker U.S. dollar, which eases debt burdens and supports commodity prices.
We expect to move into a higher nominal growth environment, which means emerging markets could continue to benefit from factors such as robust global trade and investment, strong performance in cyclical market sectors (semiconductors, financials, and commodity-linked exposures), and potential currency diversification relative to the U.S.
That said, some key risks to watch for include a renewed surge in the U.S. dollar, a slowdown in AI capital expenditures, profit-taking following strong recent gains, and further geopolitical shocks in the Middle East.
Regardless of short-term performance, emerging markets’ distinct return drivers suggest this asset class may be a meaningful portfolio diversifier over the long term—particularly for portfolios heavily weighted toward U.S. or other developed international stocks. For example:
- Diversified tech exposure: The MSCI Emerging Markets index includes global technology companies in Taiwan, South Korea, and other countries that are key parts of the AI semiconductor supply chain. That tech exposure is largely different from the types of AI companies found in some U.S. indices, which tend to be concentrated in platform/software names.
- Attractive valuations: Despite their run-up, emerging markets stocks still trade overall at significantly lower valuations than the most growth-oriented segments of the U.S. equity market. For example, the MSCI Emerging Markets index’s forward price-to-earnings ratio is currently just 13.1, versus 21.3 for the S&P 500. That could help serve as a ballast for portfolios in the event of a downturn.
Originally posted at Horizon Investments on March 4.
