Emerging Markets Can Help Offset Volatility from the AI Trade

Summary:

Emerging market (EM) equities delivered one of their strongest performances in years in 2025, and Goldman Sachs believes the asset class can continue to play a stabilizing role in portfolios in 2026. With earnings growth, a weaker dollar, easing global monetary conditions and falling commodity prices acting as tailwinds, emerging markets are increasingly seen as a counterweight to volatility driven by the concentration of artificial intelligence (AI) and technology stocks in US markets.

A standout year for emerging markets

Emerging markets surprised on the upside in 2025, even against already optimistic expectations. According to Goldman Sachs Research, developing-world equities are on track for their best annual performance since 2017. The MSCI Emerging Markets Index has returned close to 30% this year, supported by strong corporate earnings, improving macroeconomic conditions and broad-based regional gains.

Kamakshya Trivedi, chief foreign exchange and emerging markets strategist at Goldman Sachs, says replicating such performance will be challenging but not impossible. “After a great 2025, the bar is obviously very high,” Trivedi notes. “But several of the tailwinds that supported markets this year are likely to repeat in 2026.”

Goldman Sachs forecasts that emerging market equities could rise by about 13% in price terms next year, translating into roughly 16% in total returns when dividends are included.

Diversification as a buffer against AI-driven volatility

One of the most striking features of the current cycle is the role emerging markets have played in smoothing portfolio volatility. As US equity markets have become increasingly concentrated in a handful of mega-cap technology and AI-related stocks, sudden reversals in sentiment have become more frequent.

Emerging markets, by contrast, offer broad geographic and sectoral diversification. “The breadth of emerging markets is giving investors a way to moderate the sharp swings we’ve seen in US stocks,” Trivedi says. Regional diversity across Asia, Latin America, Eastern Europe and Africa helps balance portfolios at a time when AI enthusiasm has become both a driver of returns and a source of risk.

This diversification was clearly visible in 2025. In the first quarter, emerging Europe surged around 17%. In the second quarter, South Korea and Taiwan posted gains of nearly 28%, driven by technology and semiconductor strength. In the third quarter, leadership shifted to China and South Africa, each delivering returns of around 20%. Goldman Sachs expects this rotating leadership to continue in 2026.

Earnings growth remains the key driver

Looking ahead, Goldman Sachs expects the bulk of emerging market returns in 2026 to come from earnings growth rather than valuation expansion. Technology was the leading sector in 2025, particularly in North Asia, where South Korea, Taiwan and China benefited from the global AI investment boom.

The outlook remains constructive. Earnings per share are projected to grow by roughly 37% in emerging markets’ technology hardware and semiconductor sectors, and by nearly 15% in internet, media and entertainment. While AI-related themes remain important, Goldman emphasizes that returns are no longer narrowly concentrated in a single region or sector.

Resilience to global shocks

Emerging markets have also become more resilient to global shocks than in past cycles. During periods of stress in 2025 — including renewed US-China trade tensions in October and concerns about a potential AI bubble in November — emerging market equities declined less than US benchmarks such as the S&P 500.

This relative resilience reflects stronger macro fundamentals, healthier external balances and more credible monetary policy frameworks across many developing economies. “Emerging markets are responding less severely to global shocks than they used to,” Trivedi says, highlighting the asset class’s maturation over the past decade.

China’s role: exporting disinflation

China remains a central influence on the emerging market outlook. Despite ongoing tariff pressures, Chinese exports have remained surprisingly strong, reflecting the country’s cost advantages and its shift up the value chain toward capital goods such as electric vehicles, solar panels and industrial machinery.

This dynamic presents a mixed picture for other emerging economies. On one hand, China’s competitiveness intensifies pressure on manufacturers elsewhere. On the other, cheaper Chinese exports are contributing to lower inflation globally — a phenomenon Trivedi describes as “exporting disinflation.”

At the macro level, this disinflationary impulse allows policymakers in many emerging markets to ease monetary policy. At the micro level, falling input costs can support corporate margins. This environment has been particularly supportive for local-currency bond markets, which are on track for one of their strongest performances in recent history.

The Fed, the dollar and capital flows

Expected US rate cuts are another important channel supporting emerging markets. Lower US interest rates ease global financial conditions and give emerging market central banks more room to cut rates if needed.

In addition, declining US rates typically weaken the dollar, which tends to boost emerging market currencies. This currency appreciation can enhance total returns for investors holding emerging market equities and bonds. Goldman Sachs expects both channels — easier global liquidity and a softer dollar — to remain in play through 2026.

Falling commodity prices: a hidden tailwind

Lower commodity prices are also proving beneficial for many emerging economies. Commodities play a larger role in inflation dynamics in developing markets than in advanced economies. As prices for oil and other key inputs ease, inflation pressures subside, giving central banks greater confidence to loosen policy.

This trend has been especially supportive for local-currency debt markets. For equity investors, lower inflation and interest rates can translate into improved earnings visibility and higher valuations, particularly in domestically oriented sectors.

A more mature asset class

Emerging markets are often seen as high-beta assets that perform well only when global risk appetite is strong. While risk sentiment still matters, Goldman Sachs argues that emerging markets have matured significantly and are now capable of delivering returns even during periods of weakness in developed markets.

Despite strong inflows in 2025 — more than $45 billion between April and October after tariff fears eased — global mutual funds remain underweight emerging markets. This suggests there is still room for further allocation if the global growth backdrop remains supportive.

Outlook for 2026

Goldman Sachs expects the global economy to continue expanding in 2026, albeit at a more moderate pace. While equity valuations are less compelling than a year ago, the cyclical macro environment remains broadly supportive for emerging markets.

“With earnings growth, improving macro conditions and diversification benefits, emerging markets are well positioned to make further progress,” Trivedi says. For investors concerned about volatility linked to AI and concentrated US equity exposure, emerging markets may offer not just higher returns, but also a more balanced risk profile in the year ahead.

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