Emerging Markets Rally Driven by Flows, Fundamentals, Not China

In a conversation on The Markets podcast, Stratford Dennis, Head of Emerging Market Equities Trading at Goldman Sachs, reveals that the 2026 rally in emerging markets is not driven by the expected powerhouse, China, but rather by a confluence of strong global flows, robust fundamentals in other emerging economies, and a weakening dollar that disproportionately benefits markets outside of China. This analysis offers a crucial advantage to investors by highlighting the hidden consequences of conventional market thinking, which often assumes China's dominance. By understanding these dynamics, investors can identify opportunities in less crowded markets and navigate the complexities of emerging market investing with a more nuanced, systems-level perspective, avoiding the trap of chasing the wrong drivers and instead focusing on where durable advantages are being built.

The Invisible Hand of Flows: Why Emerging Markets Are Surging (Without China)

The narrative around emerging markets in 2026 has been one of consistent gains, a trend that might lead many to assume a broad-based, universally positive economic environment. However, Stratford Dennis, Head of Emerging Market Equities Trading at Goldman Sachs, offers a more intricate picture, one where the headline strength masks significant divergence and reveals how conventional wisdom about market drivers can be misleading. The core insight isn't just that emerging markets are up, but why they are up, and crucially, why China isn't the primary engine of this growth.

Dennis points to two primary drivers: robust flows and strong fundamentals. Year-to-date, global emerging markets have seen an astonishing $45 billion in inflows, already surpassing the entirety of the previous year. This isn't just a trickle; it's a flood, signaling a strong investor appetite for these assets. Fundamentally, earnings growth in emerging markets globally has been strong. This potent combination of capital seeking opportunity and companies delivering on earnings creates a powerful tailwind.

Yet, the real revelation lies in China's lagging performance. While often considered the linchpin of emerging market performance, China's earnings growth hasn't materialized as anticipated. Last year's gains were largely attributed to multiple expansion -- the market pricing in future growth -- rather than current performance. Now, the market is waiting for those earnings to catch up, and they aren't. From a flow perspective, capital is bypassing China in favor of markets like Korea, Taiwan, and even Japan. Economically, the landscape is bifurcated: exporters are doing well, but companies tied to domestic demand are struggling due to underlying weakness.

"The weaker dollar that we've seen really is in a China story. It's really an EM ex-China story."

-- Stratford Dennis

This quote is critical. It highlights a fundamental misunderstanding: the weakening dollar, a traditional tailwind for emerging markets, is not benefiting China as much as it is other emerging economies. This suggests that the market's focus on China as the sole barometer for emerging market health is a flawed approach. The real story is unfolding in "EM ex-China," a segment that is receiving both the direct benefit of dollar weakness and, in many cases, stronger underlying economic and earnings momentum. This presents a significant advantage for investors who can shift their focus from the dominant narrative to the less obvious, but more potent, drivers of growth elsewhere.

The Dollar's Ripple Effect: Latin America and the Commodity Cycle

The weakening dollar's impact is multifaceted, extending to commodity prices and specific regional plays. Dennis emphasizes that a weaker dollar often coincides with strengthening commodities, a crucial point for regions heavily reliant on resource exports. Latin America, and Brazil in particular, exemplifies this dynamic.

Dennis expresses continued optimism for Brazil, citing an expected 250 basis points of interest rate cuts, which typically benefits equities. The exposure to the commodity cycle remains a bullish factor. However, he also notes that Brazil is no longer as cheap as it once was, and positioning is less of an underweight than in the past. Despite this, the historical pattern of cutting cycles lasting longer than anticipated provides a supportive environment for equities.

This regional analysis, tied directly to the dollar and commodity cycles, underscores a systems-thinking approach. It's not just about isolated economic indicators within Brazil; it's about how global currency trends and commodity demand create a ripple effect that benefits specific emerging markets. The advantage here lies in recognizing these interconnectedness. While many might be focused on China's domestic issues, the astute investor sees the dollar's weakening as a signal to look towards commodity-rich regions like Latin America, where the fundamental tailwinds are more robust.

Derivatives as a Differentiated Play: Selling the Velocity, Not the Direction

As the conversation shifts to actionable strategy, Dennis pivots from broad market exposure to a more sophisticated derivatives approach, revealing a nuanced view on how to capitalize on continued emerging market strength without taking on excessive risk. This is where the concept of "selling the velocity" rather than just "buying the direction" comes into play, a key differentiator for those seeking a competitive edge.

Dennis, a self-proclaimed trader of derivatives and structured products, advocates for being long emerging markets, particularly EM ex-China, but through specific structures: call spreads and call ratios. The rationale is rooted in the current market environment. The significant rally in emerging markets has made upside calls very expensive, a phenomenon known as skew flattening. This means that while the market is expected to continue higher, the velocity of that move -- the speed at which it climbs -- is likely to slow down compared to the rapid gains seen recently.

"I think the difference between where I am now and where I was when I was here earlier in the year is is the structures that we have are kind of longs on should perform well but not as well if the market continues to gap the way it's done."

-- Stratford Dennis

By buying at-the-money or slightly out-of-the-money calls and selling one or two further out-of-the-money calls, investors can create call spreads and call ratios. These structures offer attractive risk-reward ratios, with potential payouts of five or six to one. This approach allows for participation in upside while hedging against excessive volatility or a sudden reversal. It’s a strategy that acknowledges the bullish outlook but prudently manages the risk associated with the market's rapid ascent. The advantage for an investor employing this strategy is clear: they benefit from continued gains but are protected from the most extreme, and potentially unsustainable, upside moves, while also generating a more favorable risk-reward profile than a simple long call position. This is a prime example of how understanding market microstructure and option dynamics can create a durable competitive advantage.

Catalysts on the Horizon: Elections and the AI Specter

Looking ahead, Dennis identifies two key catalysts that will shape the emerging markets landscape: the upcoming Brazil election and the broader market digestion of the Artificial Intelligence (AI) theme and its implications for global equities.

The Brazil election is already beginning to influence market sentiment, with the Brazilian index starting to trade around election-related news. This suggests that political developments will become an increasingly important factor for regional performance.

More broadly, Dennis acknowledges the pervasive focus on AI, particularly in US equities. He notes that while emerging markets can outperform during periods of significant sell-offs in US equities, they are not immune to overall risk sentiment. Therefore, understanding how the market digests the AI theme and its subsequent impact on global risk appetite remains central to international market strategy. This implies that while specific emerging markets may have strong fundamentals, their performance will still be influenced by global macroeconomic trends and investor sentiment, which are currently heavily swayed by technological advancements and their associated investment narratives. The challenge for investors is to disentangle the genuine, sustainable growth drivers within emerging markets from the broader, often speculative, global investment themes.

Key Action Items

• Immediate Action (This Quarter): Re-evaluate China exposure. Reduce positions if driven by speculative multiple expansion rather than concrete earnings growth.
• Immediate Action (This Quarter): Increase exposure to EM ex-China markets, particularly those with strong commodity ties, such as Latin America.
• Immediate Action (This Quarter): Implement derivatives strategies like call spreads and call ratios on key emerging market indices (e.g., MSCI EM, Bovespa) to participate in upside while managing risk and selling excess velocity.
• Short-Term Investment (Next 3-6 Months): Monitor interest rate cut cycles in countries like Brazil, as these can provide sustained tailwinds for equity markets.
• Short-Term Investment (Next 3-6 Months): Analyze the impact of global AI investment trends on broader risk sentiment and allocate capital accordingly, potentially using emerging markets as a diversifier during periods of US equity volatility.
• Medium-Term Investment (6-12 Months): Begin to assess the potential impact of the Brazil election on regional markets and adjust positioning as the political landscape becomes clearer.
• Long-Term Investment (12-18 Months+): Continue to focus on fundamental earnings growth and sustainable economic drivers within emerging markets, rather than relying on broad-based flow trends or speculative rallies. This requires patience and a commitment to understanding the underlying systems at play.