Dollar weakness sets the stage for EM outperformance in 2026

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SIMON BROWN: I’m chatting now with Herman van Papendorp, head of Asset Allocation at the Momentum Investment Group. Herman, appreciate the early morning.

Let’s start offshore. Let’s start with US equities which are looking expensive. It’s more than just the Mag Seven; we’ve even got the equal-weight S&P at highs. We’ve got the S&P Ex-Mag Seven at highs. In a recent note you put out there is profit growth. And if that profit growth remains solid we could see a soft-landing scenario. But the returns going forward are perhaps going to be a little more constrained and without much room for disappointment or missing targets.

HERMAN VAN PAPENDORP: Yes, good morning, Simon. Absolutely. I think what we have seen this year so far, in the year to date the US equity market is roughly up 20%, with something around 17% for the S&P and about 22% for the Nasdaq, So let’s call it 20%.

I think those kind of returns are unlikely to be seen next year. Whether we are we going to see a significant decline in the equity market is also probably very unlikely because of this very strong profit growth that we still have. The big risk for the US equity market would be if we have a recession in the US.

So, if we have a hard landing, that’s obviously the big risk for US equities because then the profit growth will not be forthcoming and that will expose the high valuations. But I think as we see things stand at the moment, we’re likely to go through a little bit of a soft patch in the next quarter or so when the tariff impact comes through into growth and into inflation.

Beyond that, I think as we move through the year the growth picture will look relatively solid in the US. So when we have that fiscal stimulus from President Trump starting to come through, the Fed cutting rates further, you have this kind of very strong profit-growth environment. We are unlikely to see a significant decline in the US equity market.

So we’re probably in for a sort of US equity market that will give you roughly high single-digit kinds of returns during the course of 2026.

SIMON BROWN: Which is not a bad number. It is undoubtedly down on previous returns, but not a bad number if we go abroad.

Okay, let’s take it as a given that the US is going to give us softer returns into 2026. If I look at this year, emerging markets have done better. Make no mistake, the S&P and Nasdaq had good numbers. But I raise you – 61% for our local market in dollars. Is 2026 perhaps a year of emerging markets continuing to outperform some of the developed markets?

HERMAN VAN PAPENDORP: Simon, I definitely think so. When we look at all the fundamentals for emerging markets we have that weak-dollar kind of environment likely to be maintained in 2026 because remember, firstly, global investors are saying, well, we have question marks about the US as a reliable investment destination. Structurally that puts some pressure on the dollar.

But then also in the next couple of quarters, as I said, we are likely to go through a soft patch in the US economic growth scenario and you’ll probably erode some of that positive growth gap between the US and other developed markets. So, from a growth differential perspective probably some pressure on the US as well.

And then from an interest-rate differential perspective as well, the Fed is likely to cut rates much more than other developed-market central banks. So again from an interest rate differential and a growth differential perspective, and then the structural issue, you’re likely to see a weak dollar in 2026 and a weak dollar is good for emerging markets.

Historically, emerging equity markets outperform developed equity markets significantly in this kind of dollar-weakness environment. It started to happen in 2025, but we’ve actually seen a lagging of that outperformance of dollar weakness, so I think there’s still a bit of a catch-up from 2025. And then if we see the dollar weakness being maintained in 2026, you’re likely to see that EM [emerging market] outperformance versus the developed market [DM] continuing.

But it’s not only the dollar. We also started seeing earnings revisions becoming positive in 2025 in emerging markets, upward expectations of profits outpacing the downward revisions. So that’s a positive underpin fundamentally for emerging-market equities.

And then we should not forget that the AI theme is also a good theme in emerging markets. There are a lot of AI-linked companies in emerging markets – and they’ve got higher growth rates than the US AI themes. So the valuation gap is not so much there anymore. The AI EMs are trading at the same kind of valuations as those of the US, but they give you higher growth. The PE-to-growth perspective is a big positive underpin for EMs relative to DMs. So all of these kind of fundamental factors are underpinning and then EMs are not expensive. I think therefore that’s a big positive for EMs in the global framework.

SIMON BROWN: Yes, absolutely. And not expensive relative to the US of course. The other side is, if we bring it back home, we’ve seen some foreigners buying our bonds. But if we are talking around EMs doing better, South Africa is a high beta play on EM equities. We should finally start – all things being equal – to see more foreign buying of our equities, because they have been continuing to be, the last time I checked out, net sellers.

HERMAN VAN PAPENDORP: Yes, absolutely. We haven’t seen the foreigners arriving in the equity market in SA, as you rightly pointed out. They’ve been buyers of our bonds – so they’ve been believers that SA bonds have value. But they have not been believers in SA equities as yet. History will show you that you first need to see the equity market performing well, not coming onto the radar screens of global equity investors and then start coming into our local markets.

I think what we have seen this year is that strong recent SA equity performance; that’s likely to start rekindling a little bit of that long-dormant foreign-investor interest in SA equities. So we should start seeing that.

And then if you put that back to my earlier point on emerging market equities, if you start seeing an increased global allocation to EM equities, down the food chain those global inflows into EM equities will also start supporting SA equities, as you rightly pointed out. SA is a high beta player on EM equities. So the combination of those from a flow perspective is pretty positive.

And then we still have those SA fundamentals underpinning SA asset classes. You’ve got rate cuts. The Sarb will probably come and cut a couple of times during the course of 2026. We have at least the positive growth delta in South Africa. We’re coming off a helluva low base – last year 0.5%, this year probably somewhere between 1% and 1.5%, next year probably 1.5%-plus.

So at least we are going in the right direction. For those domestic-linked companies on the SA equity market you should start seeing a little bit of an underpin as well.

And then obviously on top of all of these valuations, if you think EMs are cheap, South Africa is even cheaper than the EMs. We’re trading at one standard deviation cheaper relative to the EMs, and the EMs are cheap [compared] to the DMs. So you can just think how cheap we are relative to developed market equities.

And then, even relative to our own history, they say equities are about half a standard deviation cheaper relative to our own forward PE over the last 30 years or so.

SIMON BROWN: Yes, absolutely value. As you say, as the foreigners start to see the numbers fleshing up, the good returns, they will start coming through.

We’ll leave it there. Herman van Papendorp, head of Asset Allocation at the Momentum Investment Group, appreciate the early morning.