From cyclical recovery to structural opportunity—why emerging markets look different this time

CONTRIBUTORS

Tom Nelson, CFA, CAIA

Head of Market Strategy
Franklin Templeton Investment Solutions

Miles Sampson, CFA

Head of Asset Allocation Research,
Franklin Templeton Investment Solutions

Siddharth Chatterjee, CFA

Portfolio Manager
Franklin Templeton Investment Solutions

Ian Westley, CFA

Senior Research Analyst
Franklin Templeton Investment Solutions

Emerging markets (EMs) have lagged global indexes for over a decade due to structural challenges that have slowed growth, contributed to inflation, limited policy options and weakened corporate performance.

As investor attention turns to 2026, we believe EMs have finally entered a phase in which macro conditions, policy flexibility and corporate behavior are aligning in exciting ways, that could drive a sustained improvement in earnings quality and capital efficiency. The outperformance of EM equities during 2025 is evidence of this.

Powerful global themes such as artificial intelligence (AI), de-dollarization¹ and trade dynamics are reinforcing this transformation, changing the accepted investment calculus and increasing the prominence of EM assets in allocation decisions.

This is all happening at a time when EM equity valuations appear inexpensive relative to their developed market (DM) counterparts. On a 12-month forward basis, the FTSE EM Index trades at 15.7 times earnings, a 31% discount to DMs.²

For EM equities, the opportunity centers on rising returns on equity and falling costs of equity. Governance reforms, disciplined capital allocation, increased dividends and ongoing buybacks are enabling a potential valuation uplift. For EM debt, the appeal lies in disinflation, improved policy credibility, stronger fiscal positions and declining tail risks. These dynamics support carry, duration upside and tighter spreads, especially in local-currency markets.

EndNotes

De-dollarization – reducing the use of US dollars as a global reserve currency.
Source: Analysis by Franklin Templeton Investment Solutions (FTIS). Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Performance of the fund may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors.

Equity securities are subject to price fluctuation and possible loss of principal.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. To the extent the strategy invests in companies in a specific country or region, it may experience greater volatility than a strategy that is more broadly diversified geographically.

There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.

Large-capitalization companies may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

WF: 8130258

Important Legal Information

This document is for information only and does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

Any research and analysis contained in this document has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. Any views expressed are the views of the fund manager as of the date of this document and do not constitute investment advice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole.

There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from the use of any information, opinion or estimate herein.

The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.