Financial markets are often driven less by facts than by narratives built around those facts. Headlines compress complex macroeconomic dynamics into simplistic explanations, while investor behaviour frequently follows what is loud, recent or emotionally compelling.
Last year’s market outcomes, particularly the outperformance of emerging markets (EMs) relative to developed markets, show why a systematic, evidence-based investment approach is essential. EM outperformance was widely attributed to a weaker dollar. While currency dynamics played a role, this explanation is incomplete. A deeper examination of inflation trends, growth dynamics and central bank policy sequencing reveals a more informative story.
The global inflation surge after the pandemic was driven by a rare alignment of shocks: supply chain disruptions, expansive fiscal policy and exceptionally accommodative monetary conditions. By late 2022, inflation had reached multidecade highs across much of the developed world.
What mattered for markets last year, however, was not where inflation stood, but where it was heading. The data showed a clear deceleration in goods inflation as supply chains normalised and cost pressures eased. Freight rates, delivery times and input prices reverted to pre-pandemic norms. While services inflation remained elevated, leading indicators such as new rental agreements pointed to disinflation ahead.
These trends are important. Changes in inflation momentum feed into real interest rates, discount factors and expected asset returns. Markets respond not to inflation headlines but to shifts in inflation dynamics.
Central banks responded forcefully to inflation, but the timing and starting conditions differed meaningfully across regions. The Federal Reserve led developed markets with one of the most aggressive hiking cycles in decades, pushing real policy rates into restrictive territory.
Monetary policy, however, operates with long and variable lags. By the time inflation data visibly softened, financial conditions had tightened. In contrast, many EM central banks tightened earlier and from higher initial nominal rates. As a result, several EM economies entered last year closer to the end of their hiking cycles, while developed markets remained restrictive.
This sequencing matters. Capital flows are sensitive not only to interest rate levels but also to directionality and credibility. Empirical evidence shows that assets tend to perform best when inflation is falling, policy tightening is behind them and growth is stabilising. These are conditions that describe parts of the EM universe more accurately than those of developed markets.
Despite persistent recession fears, global growth proved more resilient than expected, particularly in the US. However, resilience should not be confused with acceleration. From an asset allocation perspective, relative growth differentials matter far more than absolute growth levels.
If dollar weakness were the sole driver, performance would have been indiscriminate
EMs contributed a disproportionate share of incremental global growth. Even modest stabilisation in large EMs had an outsized effect on risk premiums. China, while structurally slower than in past cycles, ceased to be a source of repeated negative surprises. In an environment where expectations were low, stability itself was a positive signal. Systematic valuation and macro models are designed to capture these asymmetries between expectations and outcomes.
The dollar weakened over the period, easing financial conditions and mechanically boosting EM returns in dollar terms. However, attribution analysis suggests that currency effects explain less than half of EM outperformance.
If dollar weakness were the sole driver, performance would have been indiscriminate. Instead, dispersion across countries remained high. Economies with weak fiscal positions or poor policy credibility continued to underperform. This pattern confirms that fundamentals — not narratives — were the primary force.
In evidence-based frameworks, currency is treated as a conditional amplifier rather than a root cause. It supports returns only when global macro conditions are aligned.
Valuations played a central, if underappreciated, role. Entering the year, EM assets traded at historically wide discounts to developed markets across multiple metrics. Research shows that while valuation is a weak short-term timing tool, it is a powerful predictor of long-term returns.
Systematic processes explicitly incorporate valuation by adjusting expected returns rather than making binary calls. Last year’s EM performance was therefore not an anomaly but a textbook case of mean reversion supported by improving macro fundamentals.
The conditions that drove last year’s outperformance are unlikely to repeat at the same pace. Developed market resilience may delay rate cuts, and structural challenges remain. However, EM balance sheets are stronger, inflation credibility has improved and macro dispersion has increased. In such an environment, only a systematic, data-driven investment approach can consistently identify what matters, weigh competing signals and translate complex macro dynamics into coherent asset allocation decisions.
The future of investing belongs to those who can cut through the noise — using evidence, not emotion — to understand where asset classes are truly headed.
Teichgreeber is chief investment officer at Prescient Investment Management
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