2025 has been an exceptional year for emerging market (EM) equities. South Korea has surged almost 80%, while South Africa, Brazil, and Mexico have each posted gains of more than 40% year to date. Within the MSCI country universe, six of the top 10 performers this year are emerging markets. This level of outperformance relative to the U.S. at the broad asset class level has been rare and, barring a strong late-year rotation, this will mark only the third time in the past 15 years that emerging markets have outperformed U.S. equities.
Can this trend persist or is it merely a one-year aberration? Much of the answer likely depends on the U.S. dollar, as the dollar’s trajectory has historically been the single most important driver of international equity performance compared to the U.S. When the dollar weakens, it encourages capital to search outside the U.S. for investment opportunities; when it strengthens, capital gravitates back to the U.S. in search of returns. These dynamics often reinforce themselves, as we’ve seen over the past decade where dollar strength fueled U.S. equity outperformance, which in turn supported further dollar strength.
The last extended period of EM outperformance occurred during the 2002–2008 cyclical bear market in the dollar. Over that span, the Dollar Index declined roughly 40% from peak to trough, creating a favorable backdrop for international equities. Interestingly, this episode followed a long period of U.S. dominance during the dot-com boom of the 1990s, when strong dollar conditions and technology-led growth kept global capital anchored in U.S. markets. Fast forward to 2025 and dollar weakness, particularly in the first half, has been a key driver behind strong gains in EM. However, the critical question for investors is whether this year’s move signals the start of a multi-year dollar downtrend similar to the early 2000s, or if it is merely a temporary correction within a longer-term bullish cycle. The evidence so far is mixed. While the Dollar Index is down about 8% year to date and arguably still above fair value, it remains within the broader uptrend that has persisted since 2011.
Historically, sustained dollar weakness and multi-year international equity outperformance have occurred after clear technical breakdowns in the dollar’s chart structure. At present, those signals have yet to materialize and until or unless the long-term trend decisively reverses, it is difficult to be overly bearish on the dollar or, by extension, overly optimistic about a prolonged period of EM leadership.
The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) recommends well-diversified geographic exposures, with benchmark-level allocations to the U.S., developed international, and emerging markets. Emerging market valuations remain generally attractive, and the technology/artificial intelligence (AI) outlook has improved. From a macro lens, China’s economy has stabilized (the largest country within the asset class) and trade tensions have eased. Nonetheless, the U.S. dollar outlook remains less certain and the technical picture needs to show more clarity before an EM upgrade can be more seriously considered.
Important Disclosures
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