Morgan Stanley: Emerging market equities remain more cyclical in nature, and it is hard to say a long-term bull market has begun

Overview

This is a Morgan Stanley Asia emerging market equity strategy report. The core question is whether the significant outperformance of EM equities in 2025 means that emerging market equities have entered a new long-term bull market. The report’s answer is no. The authors believe EM equities still behave more like a cyclical asset class rather than one with a unified long-term structural narrative. The traditional EM concept came from expectations since the 1980s of “convergence toward developed markets,” but in an environment of multipolarity, policy divergence, geopolitical conflict, trade friction, and widening differences in countries’ development paths, this framework’s explanatory power has clearly declined.

Core views

The report’s core views include: first, EM equities offer attractive alpha opportunities, but 2025 outperformance should not be interpreted as the start of a long-term bull market. Second, the main reason to hold EM remains diversification relative to US equities and leveraged exposure to a weaker dollar, but other assets can provide similar exposure and often with better Sharpe ratios. Third, the internal structure of MSCI EM has changed significantly, with higher weights in Taiwan, China, Korea, and India, declining weights in Latin America and EEMEA, and a rising share of EM Asia, weakening the commonality of EM as a single asset class. Fourth, EM trend earnings growth has lagged DM over the long term and is more cyclical, while energy cost sensitivity, rising IT/semiconductor weights, index concentration, and geopolitical risk all amplify volatility. Fifth, the best investment approach is not passive beta, but concentrated stock selection around themes such as a multipolar world, AI and technology diffusion, social change, future energy, with a bias toward quality style.

Analysis framework

The report builds its argument by combining asset class definitions, MSCI market classification, index weight changes, regional structural shifts, the US dollar and EM relative performance, risk-adjusted returns, efficient frontier analysis, correlations, corporate governance reform, and thematic investing frameworks. Its analysis is not a single macro forecast, but rather a multi-layered assessment of whether EM equities are suitable as a broad beta allocation from the perspectives of asset allocation, index structure, earnings quality, valuation, themes, and portfolio construction.

Methodology notes

• Index classificationMSCI market classification framework

  MSCI classifies markets into Developed, Emerging, Frontier, and Standalone based on criteria such as GDP per capita, market size and liquidity, market accessibility, capital mobility, openness to foreign ownership, and institutional investability.

  The report uses this framework to explain the narrow definition of the EM index, while also pointing out that in actual investing the EM concept may additionally incorporate factors such as company domicile, primary operating market, FX convertibility, capital account restrictions, and governance standards.

• Asset allocationEfficient frontier and Sharpe ratio analysis

  Compare the contribution of assets such as EM equities, DM equities, EM US dollar credit, and copper to portfolio risk and return through risk-adjusted returns and efficient frontier analysis.

  The report argues that over the past decade EM equities have had a weak Sharpe ratio, and adding EM equities did not materially reduce DM equity portfolio volatility or improve returns at a given risk level; by contrast, assets such as EM US dollar credit and copper delivered more meaningful improvements in risk-adjusted returns.

• Active stock selectionBest Business Models / quality style bias

  Use a quality style, systematic quality/value assessment, and concentrated portfolio selection to identify high-quality companies in EM and APxJ.

  The report says its Global EM Focus List has a history of nearly 20 years and has generated 315 basis points of annualized alpha over the long term; research since 2009 shows that a quality style performs better in EM and AXJ investing.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• MSCI EM / EM equities

  Core subject of the research; the report recommends avoiding passive beta allocation.

  Strengths

  Provides diversification opportunities relative to US equities and has historically benefited from a weaker US dollar; still offers thematic and stock-specific alpha opportunities internally.

  Weaknesses

  Trend earnings growth lags DM, cyclicality is high, Sharpe ratio is weak, index concentration is elevated, and cross-country heterogeneity is rising.

  Comparison

  Over the past decade, risk-adjusted returns have been weaker than those of Topix, FTSE 100, and MSCI Europe; relative performance versus Japan equities has not been superior.

  Risks

  A stronger US dollar, weaker EMFX, geopolitics, domestic governance, valuation mean reversion, and passive index concentration.

• Japan equities

  A structurally preferred alternative beta allocation in the report.

  Strengths

  Corporate governance reform started earlier and has been sustained; relative to EM, Japan has been in an uptrend since 2013, and performance for US dollar investors is stronger on a yen-hedged basis.

  Weaknesses

  Still affected by global risk appetite, exchange rates, and Japan’s domestic macro environment.

  Comparison

  The report explicitly states a structural OW on Japan equities, in contrast to at most an EW on MSCI EM.

  Risks

  Policy execution, FX volatility, the global technology cycle, and valuation swings.

• EM US$ credit

  As a neighboring asset, it improves the risk-adjusted return of DM equity portfolios more effectively than EM equities.

  Strengths

  The report states that adding EM US dollar credit can lift the efficient frontier and improve risk-adjusted returns.

  Weaknesses

  Affected by credit spreads, US dollar funding conditions, and sovereign/corporate credit risk.

  Comparison

  Compared with EM equities, its diversification contribution at the portfolio level has been better over the past decade.

  Risks

  US dollar interest rates, credit events, liquidity tightening, and external debt pressure in emerging markets.

• Copper / commodities / gold equities

  Alternative or complementary assets for expressing a weaker US dollar, the global cycle, and resource themes.

  Strengths

  The report says copper can improve risk-adjusted returns for DM equity investors, while gold and commodities have performed strongly in recent years and have lower beta to US equities.

  Weaknesses

  Prices are affected by global demand, supply, inventories, and policy disruptions, and volatility is high.

  Comparison

  The report argues that in some phases these assets are more suitable than EM equities for expressing weak-dollar or multi-asset diversification views.

  Risks

  A global growth slowdown, a rebound in the US dollar, rising real interest rates, and commodity price cycle reversals.

Key data

• MSCI EM total return in US dollars in 202535%The report states that MSCI EM outperformed DM equities by more than 1,000 basis points in 2025.
• Long-term alpha of the Global EM Focus List315 bps per annumThis concentrated equity portfolio is approaching its 20th anniversary, and the report says it has generated significant alpha over the long term.
• Current major weights in MSCI EMChina 24%, Taiwan 24%, Korea 17%, India 12%The chart shows China and Taiwan as the largest weights, followed by Korea and India.
• Relationship between EM vs DM and DXYR squared 0.52The report states that EM relative to DM shows a clear negative correlation with the US dollar index, and EM typically performs better when the dollar weakens.
• Revenue profile of MSCI EMApproximately 72% of revenue is domestic in natureA stronger US dollar and weaker EMFX would suppress EM EPS in US dollar terms.
• EM weight in MSCI ACWIApproximately 12%The report argues that EM is no longer as marginal an asset class in global equities as it was in the early 2000s, but this still does not constitute a sufficient reason for beta allocation.
• Japan weight in MSCI ACWIApproximately 5%The report presents Japan as one of the beta allocation choices preferred over EM.

Impact & implications

For global asset allocation, the implication of the report is: do not simply increase passive EM beta because EM outperformed in 2025. If an investor’s goal is to diversify US equity risk or express a weaker-dollar view, they should also compare alternative assets such as Japan, Europe, gold, commodities, EM US dollar credit, and copper. If EM is still allocated to, the focus should shift from index beta to country, sector, theme, and stock selection, especially around AI and technology diffusion, Asian corporate governance reform, capital market reform, future energy, and high-quality business models.

Risks

• High cyclicality in EM earnings and long-term trend EPS growth lagging DM.
• High concentration in the MSCI EM index, leaving passive strategies heavily influenced by a small number of countries and sectors.
• Geopolitical and domestic governance risks may undermine the narrative of EM as a unified asset class.
• Valuations are relatively high versus history, and recent performance has been driven largely by rerating, creating mean reversion risk.
• A stronger US dollar and weaker EMFX may suppress EM EPS in US dollar terms.
• If investors chase EM beta solely based on 2025 strength, they may overlook the long-term allocation disadvantages shown by Sharpe ratio and efficient frontier analysis.

What to watch

• The DXY dollar index and EMFX trends.
• Changes in MSCI EM country weights, especially the relative weights of Taiwan, China, Korea, and India.
• EM corporate earnings trends, energy cost sensitivity, and changes in IT/semiconductor weights.
• Progress in Korea Value Up, China’s anti-involution efforts, share buybacks, and Asian capital market reforms.
• Whether correlations within EM continue to decline, and whether thematic divergence across countries widens.
• The sustained relative performance of Japan equities versus EM and the realization of governance reforms.
• Risk-adjusted returns of EM US dollar credit, copper, gold, and commodities relative to EM equities.