Over the next few months, EEM (iShares MSCI Emerging Markets ETF) may offer more compelling upside potential than SPY (SPDR S&P 500 ETF) due to the relative valuation gap between emerging markets and U.S. equities. The S&P 500 has been trading at historically high price-to-earnings multiples, largely driven by a handful of mega-cap tech stocks. This concentration risk leaves SPY more vulnerable to any sentiment shift in the U.S. tech sector. In contrast, EEM holds a more diversified exposure across countries like China, India, Brazil, and Taiwan, many of which are trading at significant valuation discounts relative to the U.S. This gives investors the opportunity to buy growth at a cheaper price, potentially leading to stronger returns if valuations mean-revert.
Here is a chart of the ratio between EEM and SPY. Emerging markets have been underperforming for a long time. The trend has ended this year.
Another advantage for EEM in the near term is the shifting macroeconomic backdrop. With the Federal Reserve nearing the end of its tightening cycle and potentially cutting rates, the U.S. dollar could weaken, which historically benefits emerging market equities and currencies. Many EEM components are sensitive to global commodity prices and trade flows, and a softer dollar often boosts both. At the same time, some emerging economies are already ahead in their rate-cutting cycles, meaning local monetary conditions may turn more supportive of growth faster than in the U.S. If global investors start rotating into undervalued, high-growth regions, EEM could be a primary beneficiary.
Finally, geopolitical and supply chain trends may work in EEM’s favor over the coming months. Several emerging markets are attracting increased foreign direct investment as companies diversify manufacturing away from China into countries like India, Vietnam, and Mexico. This shift supports long-term growth prospects and may translate into stronger earnings momentum for EEM constituents in the short term. In contrast, SPY’s near-term performance is more closely tied to the mature U.S. economic cycle and earnings expectations that may already be priced for perfection. In an environment where global growth is rebalancing, EEM provides exposure to regions with both higher growth potential and improving investor sentiment, making it a potentially better tactical play than SPY for the months ahead.
Dennis Leontyev
