By Christine Idzelis
Emerging-market stocks still look relatively cheap even after their big rally, says a portfolio manager at Causeway Capital Management
An ETF that tracks the MSCI Emerging Markets Index is on track to beat the S&amp;P 500 this year by the widest margin since 2017, according to Dow Jones Market Data.
Emerging-market stocks have broadly crushed the U.S. equities market this year, in one of the biggest market surprises of 2025.
&#34;EM outperformance comes after years and years of underperformance,&#34; Arjun Jayaraman, a portfolio manager for emerging-market equities and head of quantitative research at Causeway Capital Management, said in a phone interview. &#34;It's like the rubber band got really stretched in one direction,&#34; as the U.S. had long beaten emerging-market equities, he said.
But this year, a large exchange-traded fund that tracks the MSCI Emerging Markets Index is on pace for its widest outperformance relative to the S&amp;P 500 SPX since 2017, according to Dow Jones Market Data.
Stocks in emerging markets have benefited from a decline in the U.S. dollar this year as well as some exposure to the artificial-intelligence boom. Jayaraman anticipates that with the MSCI Emerging Markets Index currently trading at a cheaper valuation than the S&amp;P 500, this year's strong run may extend into 2026 under a potential shift to sustainable outperformance as investors seek to diversify beyond U.S. stocks.
Shares of the iShares MSCI Emerging Markets ETF EEM have soared 26.7% this year through Tuesday, easily exceeding the S&amp;P 500's 15.6% climb over the same period. The fund is heading for its biggest annual gain since 2017.
The iShares MSCI Emerging Markets ETF is beating the S&amp;P 500 this year by 11.1 percentage points through Dec. 16, which put it on track for its widest annual outperformance since trouncing the U.S. benchmark index by 15.2 percentage points in 2017, according to Dow Jones Market Data.
&#34;Overweighting the U.S. has served global investors well the past 15 years,&#34; Lisa Shalett, Morgan Stanley Wealth Management's chief investment officer, said in a note dated Dec. 15.
But &#34;one of the most underappreciated opportunities may be in EM equities,&#34; she wrote, calling their &#34;extraordinary outperformance&#34; in 2025 among the biggest surprises of the year.
&#34;While first-half U.S. dollar weakness certainly helped, the fact that EM has done so well amid shifting geopolitics and aggressive U.S. tariffs is impressive, leading us to ask whether it is entering a multiyear outperformance trend,&#34; said Shalett.
President Donald Trump has this year imposed large tariffs - levies paid by U.S. companies on imported goods. Businesses may then choose to pass those costs on to consumers in an effort to protect their profit margins.
&#34;For those who anticipated U.S. tariff policies generating major headwinds for export-dependent EM countries, the degree of outperformance has to be surprising,&#34; said Shalett. &#34;EM relative outperformance has not only held up but widened as the year has matured.&#34;
An interesting aspect of emerging-market outperformance this year is that the &#34;usual suspects aren't the ones leading the charge,&#34; according to Jayaraman. India is a long-term strong performer, yet the country's equities market has lagged this year while South Korean stocks surged, he said.
South Korea has helped fuel a massive gain this year for the Freedom 100 Emerging Markets ETF FRDM, which tracks an index of emerging-market stocks in countries that score higher on personal and economic freedom, according to Perth Tolle, the founder and chief executive officer of Life + Liberty Indexes.
South Korean stocks that stood out with &#34;huge&#34; gains for the ETF this year are Samsung Electronics Co.  (KR:005930) and SK Hynix Inc. (KR:000660), which have benefited from the AI boom in emerging markets along with Taiwan Semiconductor Manufacturing Co. (TSM), she said in a phone interview.
&#34;It's a banner year&#34; for the ETF, she said, citing South Korea, Poland and Chile as among the fund's top drivers of gains. Tolle created the index tracked by the ETF, whose shares have skyrocketed 50% in 2025 through Dec. 16, according to FactSet data.
The Freedom 100 Emerging Markets ETF seeks exposure to &#34;the freest emerging markets, because we believe those are the places to find the next big growth stories,&#34; Tolle said. For example, &#34;we are in countries that have freer trade policies,&#34; which has helped them to be more resilient in the face of U.S. tariffs, she added.
Jayaraman also pointed to big gains this year from Samsung and SK Hynix as part of the AI theme, but he added that away from those two South Korean &#34;tech giants,&#34; the country has &#34;a lot of interesting things happening&#34; in terms of corporate-governance reform.
EM stocks still look cheap
Stocks in emerging markets generally still look relatively cheap after years of underperformance, helping set the stage for their rally to continue, according to Jayaraman.
He said the MSCI Emerging Markets Index has been trading at a price-to-earnings ratio of around 13 on a forward 12-month basis, a valuation that is below the S&amp;P 500's multiple of around 22 to 23.
&#34;When you're thinking about emerging markets, your benchmark can be important,&#34; Nick Kalivas, Invesco's head of factor and equity ETF strategy, said in an interview. For example, the MSCI Emerging Markets Index includes South Korea, but the FTSE Emerging Index does not, he explained, which can make a difference in performance.
While shares of the Vanguard FTSE Emerging Markets ETF VWO have posted a strong gain of 21.4% this year through Dec. 15 to beat the S&amp;P 500 so far in 2025, the index fund has trailed the iShares MSCI Emerging Markets ETF over that same period, FactSet data show.
The Invesco RAFI Emerging Markets ETF PXH - which tracks an index of emerging-market companies but does not include South Korea -  is outperforming the FTSE benchmark, as the fund weights companies by their &#34;economic footprint&#34; as opposed to their market value, said Kalivas.
China has the biggest weight in the iShares MSCI Emerging Markets ETF, the Vanguard FTSE Emerging Markets ETF and Invesco RAFI Emerging Markets ETF, but Chinese stocks are not tracked by the Freedom 100 Emerging Markets ETF, which excludes autocracies.
Watching the U.S. dollar
U.S. investors in emerging-market equities generally have gotten a tailwind from the dollar's decline this year, with the currency conversion adding to the local gain they have seen from those stocks, according to Causeway's Jayaraman.
Invesco's Kalivas also cited the currency benefit, adding that the softer greenback can help make financing less expensive for emerging-market companies that borrow in U.S. dollars.
&#34;What we saw earlier in the year is a lot of our clients thinking we want to get some overseas exposure because the dollar weakened,&#34; he said in an interview. &#34;When the dollar weakens, that has historically been good for international markets.&#34;
The ICE U.S. Dollar Index DXY, a measure of the greenback against other major currencies, has fallen more than 9% so far this year, according to FactSet data, at last check on Wednesday.
Part of the dollar's softening is the result of the Federal Reserve's interest-rate-cutting cycle, with the Fed's easing of monetary policy helping to put a cap on the dollar's strength, said Kalivas.
&#34;People will be watching the dollar very very closely,&#34; he said. &#34;That will probably be a big linchpin of the EM trade.&#34;
-Christine Idzelis
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<p>Emerging-market stocks have outperformed the S&P 500 in 2025, driven by a weaker U.S. dollar and AI exposure. The iShares MSCI Emerging Markets ETF has gained 26.7%, surpassing the S&P 500's 15.6% rise. Analysts suggest this trend may continue into 2026, as investors diversify beyond U.S. stocks. South Korean stocks, particularly Samsung and SK Hynix, have contributed significantly to this performance. The Freedom 100 Emerging Markets ETF has surged 50%, highlighting opportunities in countries with freer trade policies.</p>

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