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By Laura Matthews and Rodrigo Campos
NEW YORK, Feb 2 (Reuters) - Global investors poured money into emerging market stocks at the fastest clip in years in January, as a weaker dollar and diversification away from the U.S. point to an extension of the rally the asset class staged last year.
Emerging market equity funds last week posted one of their biggest weekly inflows on record, lifting year-to-date inflows above $39 billion, according to J.P. Morgan. That marks one of the strongest starts to the year for EM equities in more than 20 years, the investment bank said, and has historically been associated with sustained rallies rather than brief bursts of optimism.
Latin American equity funds recorded their strongest weekly inflows on record.
Some fund managers say the shift reflects a rare alignment of macro and fundamental signals - in particular, currency dynamics and stabilizing earnings expectations.
The U.S. dollar fell more than 9% last year against a basket of developed-nation peers while the EM currency index added more than 7%, the most since 2017, and expectations for continued weakness in the greenback are pushing investors further into other geographies. The S&P 500 rose 16.4% last year and the EM index was up 30.6%.
The dollar has been a headwind for EMs for years, according to Varun Laijawalla, an emerging market equity portfolio manager at Ninety One. "Last year you saw a break in that trend, and that changes the backdrop for emerging markets," he said.
FOCUS ON INDIVIDUAL COUNTRIES
Some investors said the pattern of inflows also points to a more selective approach than in past EM rallies, with buyers focusing on individual countries rather than treating emerging markets as a single trade.
"What’s really standing out this time is how much investors are using single-country emerging market ETFs," said Dina Ting, head of global index portfolio management at Franklin Templeton.
That selectiveness reflects wide performance gaps across countries, and a view that macro and policy conditions now matter more at the national level than in recent years, investors said. They are also focusing on tighter central bank discipline in some larger emerging economies such as South Korea and Brazil and stronger constraints on government spending, compared with the U.S.
"If I want policy orthodoxy and fiscal responsibility, I go to EM, not DM," said James Athey, a fund manager at Marlborough in London. Some developed countries are spending as if their economies need support, increasing longer-term risks, he said.
IMPACT OF DOLLAR WEAKNESS
The dollar’s multi-year lows have been driven in part by investors reassessing Washington’s policy direction and geopolitical risks, including President Donald Trump’s tariff threats and his administration’s pressure on the Federal Reserve’s independence.
"I find it hard to believe that the U.S. as an asset class could carry an extra premium when you have so much going on," said Jorry Noeddekaer, head of Polar Capital’s emerging markets and Asia team.
A softer dollar can lift emerging market corporate profits by easing financing costs and supporting domestic demand.
Economic growth in developed economies is forecast to be 1.8% this year and 1.7% next, according to the International Monetary Fund, while EMs are projected to expand by 4.2% this year and 4.1% in 2027. Investors are betting that corporate earnings in emerging markets will follow economic growth.
"For the first time in years, earnings are no longer a drag. That’s essential if this rally is going to be sustained," Laijawalla said.
KEY EXPOSURE TO ARTIFICIAL INTELLIGENCE
While artificial intelligence stocks have dominated the conversation in the U.S., some investors note emerging markets also offer exposure to the category, particularly through suppliers of semiconductors and advanced manufacturing equipment in South Korea and Taiwan.
South Korea’s KOSPI index rose more than 75% last year and close to 97% in dollar terms. It was up 24% in January, its strongest monthly performance since December 1998.
"That momentum has room to continue," said Steve Kolano, chief investment officer at Integrated Partners. "So we’ve been ... getting much closer to a benchmark weight in emerging markets".
Some investors also are diversifying beyond AI and into emerging markets more closely tied to domestic consumption and younger populations.
"Emerging markets offer exposure to very different parts of the global economy, including consumer sectors that are less tied to the AI investment cycle," said Andrew Briggs, director of portfolio management at Plaza Advisory Group.
