Why Wells Fargo Expects the Emerging-Markets Outperformance to Reverse

This year, emerging-market equities have significantly outperformed the S&P 500, prompting investors to ponder the sustainability of this trend. However, in a recent report, Wells Fargo analyst Austin Pickle presents a contrarian view, suggesting that the current relative strength of emerging markets is set to reverse.

Outperformance by Emerging Markets

In 2025, emerging markets (EM) have shown a remarkable 10% relative outperformance against the S&P 500 since January. This trend can largely be attributed to a few key factors: institutional underweights in the asset class, extremely low market sentiment, and favorable valuations. As the year progresses, the S&P 500 has already reported two consecutive years of nearly 25% returns. This juxtaposition of performance raises significant questions about the long-term viability of emerging markets maintaining their current strength.

Market Volatility and Changing Sentiment

The landscape has shifted, particularly with this year’s heightened volatility and signs that China may be nearing an economic bottom. Coupled with a weakening dollar, these factors may have temporarily swung the pendulum back in favor of emerging markets. However, this reversal of fortunes was anticipated and closely monitored.

Historical Context

As 2024 drew to a close, emerging market indices were reflecting a 15% decline over an extensive period of 18 years, a trend that predated the global financial crisis. During this time, corporate earnings within the space had scarcely grown, contrasting sharply with the performance observed in the S&P 500. Pickle attributes these underwhelming years to various factors, including:

• Political instability
• Economic uncertainty
• Poor corporate governance
• Unreliable regulatory frameworks
• Chinese market challenges such as a real estate bubble, excessive debt, and slowing growth

The Dollar’s Role in Emerging Market Performance

A crucial aspect of the emerging markets’ trajectory lies in their historical performance patterns correlated with the strength of the dollar. Pickle notes that EM stocks tend to perform best during periods of dollar weakness. As such, Wells Fargo anticipates that while emerging-market stocks could continue to appreciate, they are likely to underperform compared to their U.S. counterparts in the near future.

Lingering Trade Concerns with China

Another factor inhibiting potential growth in the emerging markets is the protracted trade tensions with China. Given that China constitutes approximately 30% of the MSCI Emerging Markets index, ongoing tariff disputes are expected to dampen the overall performance of this index. This dependency on China’s economic health represents a significant risk for the entire emerging market sector.

A Favorable Outlook for Developed Markets

Looking longer-term, Wells Fargo expresses a preference for the more predictable and stable political environment and regulatory frameworks characteristic of developed markets. This insight lends itself to Wells Fargo’s recommendation for investors to consider trimming their exposure to emerging-market equities and look towards repositioning their investments favorably within the U.S. and broader developed market landscape.

Conclusion

As volatility continues to mark financial markets in 2025, the outlook for emerging markets must be approached with caution. While the recent outperformance has caught the attention of investors seeking opportunities in undervalued assets, the economic realities and geopolitical challenges ahead suggest a potential slowdown in momentum. With a robust recommendation for a redirection towards developed markets, the conclusions drawn by Wells Fargo serve not only as a forewarning but also as a guide for future investment strategies.