Emerging Market Equities in Q2 2025: Rebalancing for Long-Term Growth Amid Global Macro Shifts

In the second quarter of 2025, emerging market (EM) equities delivered a compelling performance, returning 12% as measured by the MSCI EM Index—outpacing the S&P 500's 11% gain. This marks the second consecutive quarter of outperformance, driven by a surge in tech-driven economies and a weaker U.S. dollar. For investors seeking to rebalance portfolios for long-term growth, EM equities now present a unique opportunity amid shifting global macroeconomic dynamics.

The Drivers of EM Resilience

The rebound in EM equities was fueled by two key sectors: Information Technology (+24%) and Industrials (+22%). South Korea and Taiwan, with their semiconductor and AI infrastructure ecosystems, led the charge. Companies like Taiwan Semiconductor and SK Hynix surged on strong global demand for chips, while South Korea's industrial sector benefited from green energy investments and automation trends.

However, the story wasn't uniformly positive. The Consumer Discretionary sector (-3%) and Consumer Staples (+6%) lagged, with Chinese e-commerce giants like Alibaba and JD.com struggling against intensifying competition. Meanwhile, Saudi Arabia's market fell 5%, reflecting domestic policy adjustments and geopolitical uncertainties.

Global Macro Shifts: A Tailwind for EM

The broader macroeconomic environment has created favorable conditions for EM equities. J.P. Morgan Research notes that EM central banks are cutting rates to offset weaker domestic growth, while the U.S. Federal Reserve remains on hold. A weaker dollar—projected to depreciate further against EM currencies—has boosted investor appetite for dollar-denominated EM assets.

Trade policy tensions, however, remain a double-edged sword. Rising U.S. tariffs have front-loaded industrial activity but are expected to drag on growth in the second half of 2025. For EM economies, this creates a paradox: while tariffs disrupt global supply chains, they also redirect capital toward domestic manufacturing and tech innovation in countries like India and Vietnam.

Rebalancing for Long-Term Growth

Portfolio managers at Martin Currie Global Emerging Markets have leaned into these trends by overweighing Information Technology and Energy sectors. Their strategic additions—such as Clicks Group (South Africa's health and beauty retailer) and Inter (Brazil's digital bank)—highlight a focus on defensive, high-growth businesses. Conversely, exits like LG Chem and GlobalWafers reflect a shift away from cyclical sectors facing near-term headwinds.

For investors, this underscores the importance of sectoral diversification and currency hedging. While EM equities offer attractive valuations (MSCI EM is trading at a 30% discount to the S&P 500), volatility remains a risk. A balanced approach—overweighting AI-driven tech and energy while underweighting overleveraged consumer sectors—can mitigate short-term shocks while capturing long-term growth.

Navigating the Risks

Geopolitical tensions and U.S. debt dynamics pose challenges. The Congressional Budget Office's projection of a $21 trillion deficit over the next decade could push U.S. long-term yields higher, potentially siphoning capital from EM markets. Additionally, energy markets remain fragile, with oil prices stabilizing in the mid-60s range due to disrupted trade flows.

Investors should also monitor gold and copper as barometers of macroeconomic sentiment. J.P. Morgan forecasts gold to reach $3,700 by year-end, driven by central bank purchases, while copper prices may reflect trade policy shifts under Section 232 tariffs.

The Path Forward

Emerging market equities are no longer a speculative bet—they are a strategic asset class for long-term growth. The key lies in selectivity: focusing on high-growth sectors like AI, semiconductors, and renewable energy, while avoiding overexposed consumer markets.

For rebalancing portfolios, consider:
1. Overweighting EM tech and energy: Position in companies like Taiwan Semiconductor and Localiza (Brazil's car rental firm).
2. Diversifying currency exposure: Allocate to EM currencies expected to outperform, such as the CNY and INR.
3. Hedging against volatility: Use derivatives to mitigate risks from U.S. rate hikes and geopolitical shocks.

In a world of stagflationary risks and shifting trade policies, emerging markets offer a rare combination of resilience and growth potential. By rebalancing portfolios to capitalize on these dynamics, investors can position themselves to thrive in the next phase of the global economy.