EM Growth and the Dollar Cycle: A Commodity-Focused Rebalance

The rotation into non-US assets is no fleeting trend. It is a response to a fundamental shift in the global macro engine, where the US dollar's dominance is showing cracks and growth is diverging sharply. This setup creates a powerful, cyclical tailwind for a rebalance.

The primary catalyst is the sustained weakness in the US dollar. The DXY index has fallen over 10% from its 2024 peak, a significant move that has supported a rotation into non-US assets. This decline is not just a technical shift; it reflects a broader, structural trend of global dollar diversification. As foreign investors seek to rebalance their portfolios, the weakening dollar makes international holdings more attractive to US-based investors, providing a direct boost to returns. This dynamic was a key driver behind the almost 9% decline in the dollar for 2025, fueling a powerful comeback for international stocks.

Simultaneously, global growth is taking on a more uneven profile. The United States is maintaining above-trend expansion, powered by an unprecedented capital expenditure cycle in data centers and AI-related technology. This structural strength is creating a domestic growth engine that is distinct from the post-inflation world of Europe and the UK. In contrast, the Eurozone and the UK face a clear bias to the downside, with subdued momentum and less buoyant outlooks. This divergence in economic trajectories is shaping investor strategy, as capital naturally flows toward the regions with stronger growth momentum.

The result is a valuation opportunity. After a decade of US equity dominance, international stocks are trading at significant discounts. This gap offers a potential entry point for investors seeking to rebalance. The combination of a weakening dollar, diverging growth, and attractive valuations sets up a favorable macro backdrop for a sustained shift in asset allocation. The question now is whether this marks the start of a durable trend or a temporary reprieve. The cycle, however, appears to be turning.

Commodities as the Engine: EM Growth Meets Dollar Dynamics

The macro backdrop is now translating directly into commodity markets. The powerful rotation into emerging markets is not just a financial asset story; it is a proxy for a global shift in economic activity and demand. When EM equities delivered a 34% return in 2025, the largest outperformance versus the S&P 500 in 17 years, it was a clear signal that capital is flowing toward the engines of global growth. That flow is a primary driver for commodities.

This cycle is powered by two converging forces. First, the sustained weakness in the US dollar acts as a direct catalyst for commodity prices. A weaker dollar makes raw materials priced in dollars more affordable for international buyers, boosting demand. Second, and more fundamentally, it is the surge in global capital expenditure that is creating a structural demand tailwind. As the evidence notes, EMs perform strongly when global capital expenditure (capex) rises. The current wave of investment in data centers, AI infrastructure, and semiconductor manufacturing-led-by structural champions like Taiwan and South Korea-is a major source of this capex. This investment directly fuels demand for copper, aluminum, steel, and other industrial metals.

The result is a re-rating of EM's long-term competitiveness. Structural themes are enhancing resilience, which in turn supports the sustained commodity demand cycle. Improved corporate governance and stronger balance sheets mean EM producers are better positioned to manage costs and invest in capacity. This creates a virtuous loop: stronger EM growth supports commodity prices, which can improve EM producer earnings, further justifying the equity outperformance.

Yet, a critical risk remains in the positioning. The rally has been massive, and investor flows tell a crowded-trade story. While EM ETFs saw massive inflows, non-ETF flows were actually out of the region. This divergence signals that the trade is now well-established, with retail and passive money leading the charge. Such crowded positioning can amplify volatility. A shift in sentiment, perhaps triggered by a stronger dollar or a growth scare, could lead to a sharp reversal in EM equities and, by extension, commodity prices.

The bottom line is that the macro cycle is set for a commodities-driven expansion. The combination of a weaker dollar, rising global capex, and EM growth convergence provides a powerful, multi-year tailwind for raw materials. However, the current valuation and positioning of EM equities mean that this cycle is likely to be marked by periods of strong momentum punctuated by bouts of volatility. The long-term trend is clear, but the path will not be smooth.

Valuation and Forward Scenarios: Defining the Trade

The rally has been powerful, but the valuation gap remains a critical anchor for the trade. Even after a 33.6% gain in 2025, emerging market equities are still deeply undervalued. The MSCI Emerging Markets Index trades at a forward price-to-earnings ratio of 13.5x, which is 32% cheaper than developed markets and a striking 40% cheaper than the US. This discount provides a tangible margin of safety. In practice, it means the market is pricing in a continuation of the past decade's underperformance, not the new cycle of structural growth and capital expenditure that is now unfolding. For the trade to hold, this valuation must be re-rated as fundamentals catch up.

The sustainability of that re-rating hinges on a single metric: earnings growth accelerating beyond the current 7-8% range. Preliminary data shows 16% EPS growth in 2025, with estimates calling for more than 20% growth in 2026. That acceleration is the linchpin. It requires the current wave of global capital expenditure-driven by AI infrastructure, semiconductors, and energy transition-to translate consistently into corporate profits across EMs. Structural improvements in balance sheets and governance are helping, but the cycle will stall if this capex does not convert into robust, durable earnings.

The liquidity backdrop will be defined by two macro forces. First, the trajectory of the US dollar is paramount. The powerful decline that fueled the 2025 rally is a key tailwind, but its sustainability is uncertain. A reversal, perhaps triggered by a stronger-than-expected US economy or a shift in Fed policy, would immediately pressure EM returns and commodity prices. Second, global interest rates will shape the risk appetite for international assets. The expectation of Fed rate cuts and a more accommodative global monetary policy environment has been supportive. Any premature tightening or prolonged high-for-longer dynamics would tighten the screws on valuations.

The bottom line is that this is a trade defined by a durable macro cycle, not a fleeting sentiment shift. The setup-weak dollar, rising capex, structural EM growth convergence-creates a powerful multi-year tailwind. Yet, the path will be volatile. The crowded positioning in EM equities, highlighted by massive ETF inflows, means the market is sensitive to any change in these fundamental drivers. The watchpoints are clear: monitor EM earnings acceleration, the dollar's trend, and the global interest rate path. If these remain aligned, the valuation gap offers a compelling opportunity. If they diverge, the rally's momentum could quickly fade.