Emerging Markets Stocks Are Outperforming the U.S. Why the Rally Can Continue.

A weakening U.S. dollar is helping boost emerging market stocks. (Ricky Carioti/The Washington Post via Getty Images)

Emerging markets stocks are beating U.S. equities this year, thanks to a weakening dollar and a resurgence of China’s stock market. Both trends look set to continue, at least in the short term.

After years of underperformance, developing country stocks have been soaring this year. The iShares MSCI Emerging Markets exchange-traded fund, a popular index fund targeting the sector, has returned 20.7% year to date, nearly double the 10.5% return for the S&P 500.

Emerging markets aren’t a core holding for most U.S. investors. But, based on market capitalization, they should make up about 10% of investors’ stock portfolios, compared to about two-thirds for U.S. stocks. While placing too big a bet on volatile emerging markets could be foolish, any additional outperformance might provide a nice tailwind to your overall returns this year.

A key factor behind the rally is the slumping U.S. dollar, which has fallen about 7% so far in 2025, one of its worst stretches in decades.

A weak U.S. dollar makes foreign goods more expensive for U.S. consumers—but by the same token, it increases the value of foreign company profits and stock prices from the perspective of U.S. investors. The dollar selloff has added about three percentage points to the MSCI Emerging Markets Index’s total return this year, according to Dow Jones Markets data.

The dollar’s slide is due to a host of factors, including a slowing U.S. economy, a chaotic situation in Washington, and anticipation that the Federal Reserve will cut interest rates later this month. Lower interest rates should reduce yields on Treasuries and other U.S. assets, potentially leading global investors to cash out dollar holdings—and putting more downward pressure on the U.S. currency.

None of the trends weighing on the dollar’s value show signs of reversing in the near term. Last month, Morgan Stanley analysts forecast that the U.S. dollar could lose another 10% by the end of 2026.

“We’re likely at the intermission rather than the finale,” noted currency strategist David Adams.

Another driver of emerging markets returns is China. The world’s second-largest economy makes up about 30% of the emerging markets universe, well ahead of the next largest nations Taiwan (19%) and India (16%), according to the MSCI EM index.

The iShares MSCI China ETF has jumped more than 32% in 2025, after a miserable stretch between 2020 and 2023, when it lost roughly half its value. The Chinese economy remains plagued with problems—from weak consumer spending and a yearslong real estate crisis.

Nonetheless, there has been good news too, such as excitement around the nation’s DeepSeek artificial-intelligence model. There is also growing confidence in the government’s so-called anti-involution effort, designed to head-off debilitating price-cutting in industries like the booming electric car market.

Despite 2025 price gains, Chinese stocks trade at just 13 times forward earnings. That is about average for emerging markets, but well below U.S. stocks, which trade at around 22 times. Such a cheap valuation is one reason China and emerging markets stocks could continue to deliver gains, according a note from Goldman Sachs on Wednesday.

“Our China strategists think that the rally has further to go,” wrote the Goldman team led by emerging markets strategist Kamakshya Trivedi.

Write to Ian Salisbury at ian.salisbury@barrons.com