UBS stays selective in EM equities as valuation tailwinds fade

UBS maintains a Neutral stance on emerging market equities, citing fading valuation tailwinds as the MSCI EM Index now trades slightly above its 10-year average forward P/E, limiting near-term upside without substantial earnings revisions. While strategically positive on EM exposure, the firm advises a highly selective approach, recommending adding on pullbacks and favoring markets like mainland China tech, India, Taiwan, and Brazil due to structural drivers and policy support, while cautioning on potential volatility from upcoming trade developments.

Analysis

UBS maintains a cautious and Neutral stance on emerging market (EM) equities, advocating for a highly selective investment strategy. The firm notes that while EM equities have outperformed the S&P 500 year-to-date, this rally was primarily driven by a P/E rerating and favorable currency movements rather than fundamental earnings growth. Consequently, the MSCI EM Index's forward P/E multiple has risen to 12.6x, slightly above its 10-year average of 12.2x, removing valuation as a clear tailwind for future performance. UBS sees limited near-term upside without more substantial earnings revisions and has set a December 2025 target of 1,190 for the index. The bank's preferred markets, all rated 'Attractive,' include mainland China tech, India, and Taiwan, citing structural growth drivers and policy support. Brazil was also recently upgraded to 'Attractive' due to supportive policy expectations and relative insulation from global trade tensions. Key risks on the horizon include potential volatility from the expiration of a U.S. reciprocal tariff pause in July and August, as recent U.S.-China talks have yet to yield concrete de-escalation details. While a weaker U.S. dollar provides a supportive backdrop, UBS warns against over-reliance on currency trends, emphasizing that the strategic case for EM exposure requires a near-term focus on earnings and trade developments.

Key Decisions for Investors

• Adopt a highly selective approach, focusing on specific markets with strong fundamentals such as mainland China tech, India, Taiwan, and Brazil, rather than pursuing broad, passive EM index exposure.
• Consider adding exposure on market pullbacks rather than chasing the current rally, as valuations are no longer considered a significant tailwind for immediate gains.
• Closely monitor U.S. trade policy developments, particularly the expiration of the tariff pause in July and August, as this is a key identified catalyst for potential near-term volatility.
• Prioritize companies with strong earnings growth and positive revisions, as these will be the primary drivers of performance in an environment of neutral-to-expensive valuations.