In a significant shift for global finance, emerging markets are emerging as the favored trade on Wall Street as 2026 begins. Money managers are betting that a multi-year cycle of investment inflows is now firmly underway, marking a dramatic turnaround for an asset class that was once considered out of favor.
The Great Turnaround: From Skepticism to Enthusiasm
The capital rush into emerging market securities in 2025 has been the strongest since 2009. This surge signals that more investors are finally allocating funds to a sector that suffered from years of disappointing performance. For the first time since 2017, emerging market stocks are outperforming their US counterparts. Furthermore, the yield gap between emerging market bonds and US Treasuries has shrunk to an 11-year low, and carry trade strategies have delivered their best profits since 2009.
The renewed optimism was palpable at a recent Bank of America Corp. investment conference in London. The event, which hosted 300 investors across 170 meetings, revealed hardly any pessimism toward emerging markets. David Hauner, BofA’s head of emerging fixed income, declared, “EM bears have gone extinct.”
This shift points to a more fundamental change in global investment flows. Portfolio managers are actively seeking to diversify away from concentrated US exposure. They are increasingly attracted by developing nations' progress in reducing debt and controlling inflation, making these markets appear more stable.
Banks Join the Bullish Chorus: AI and Dollar Weakness as Catalysts
Major financial institutions like JPMorgan Chase & Co and Morgan Stanley have added their voices to the bullish outlook. They predict emerging markets will benefit from a weaker US dollar and the massive investment wave in artificial intelligence. JPMorgan projects up to $50 billion in inflows into emerging-market debt funds next year.
“One of our best ideas is still to hang with local emerging-market debt,” said Bob Michele, global head of fixed income at JPMorgan Asset Management Inc. He anticipates price appreciation, carry collection, and further upside for emerging market currencies. Morgan Stanley similarly advises clients to hold local-currency bonds and buy more dollar-denominated emerging debt, while BofA expects hard-currency emerging bonds to repeat 2025's double-digit returns.
A key factor supporting further growth is positioning. Despite the rally, investment flows remain relatively modest. US ETFs focused on EM stocks absorbed nearly $31 billion in 2025, according to Strategas Securities. Emerging debt funds have attracted over $60 billion, per EPFR Global data compiled by BofA. However, this follows massive outflows of $142 billion in the preceding three years, indicating that emerging markets are still under-represented in global portfolios.
Todd Sohn, senior ETF and technical strategist at Strategas, called 2025 “the return of asset allocators after a brutal five-year stretch.” He noted that many investors realized they were overexposed to US large-cap growth equities and moved to diversify globally.
Potential Challenges: The Dollar and China's Shadow
Despite the optimism, vulnerabilities persist. China, trapped in a deflationary cycle, could challenge other developing countries by exporting excess capacity, pressuring local industries. The most significant test, however, is the US dollar. Its 8% decline in 2025 buoyed emerging assets, but a rebound is possible if the Federal Reserve cuts interest rates less than expected.
Citigroup Inc. strategists, for instance, advise clients to buy only emerging assets that can withstand a potential greenback bounce. Nevertheless, the bank still expects 5% total returns from emerging bonds next year. JPMAM's Michele remains bullish, believing “very high” real yields will continue to attract investors even if the dollar strengthens.
For now, the momentum is strong. Emerging-debt funds absorbed $4 billion in the week to December 17, the largest weekly inflow since July. According to Sammy Suzuki of AllianceBernstein, if emerging markets withstand shifts in dollar strength and Fed policy, cautious investors may become convinced a structural re-allocation is truly happening.
“This uncertainty provides investors with a window of opportunity to jump in,” Suzuki stated. “Once everyone believes in it, it might be too late.”
