This is a two-part series on small caps. This week, we look at historical small caps performance, recent small caps performance and the reasons behind the unexpected. Next week, we’ll dive into what this means for allocators and skeptics.

The case for a meaningful small-cap allocation in institutional portfolios

Small caps have just done something the textbook says they should not have. Since the Middle East conflict began at the end of February 2026, small caps have outperformed large caps on both sides of the Atlantic – through an oil-price spike, a sharp re-pricing of European front-end rates and deeply negative eurozone economic surprises. Inside those headline numbers, that is not the behaviour of an asset class to be avoided.

Source: Bloomberg

Small caps have outperformed large caps on both sides of the Atlantic for the last two years.

Source: Bloomberg

Crowded at the top, despite a universe of options

MSCI’s classification methodology defines small caps as roughly the bottom 14% of free-float market capitalization in each country it covers. This creates a universe that spans over 12,000 listed companies and the institutional allocation to that universe has, if anything, contracted. Even within the S&P 500, long-only funds remain overweight the largest quintile by market cap and underweight the smallest. The result is a public-equity allocation that, for all its sophistication, is structurally tethered to the same fifty or so mega-caps that everyone else owns.

As we observed in our September 2025 article, “Why small caps are built for what’s next,”* three of the four episodes of extreme S&P 500 top-ten concentration over the past century – the Go-Go conglomerate years, the Nifty Fifty, and the dot-com boom – were each followed by extended periods of small-cap leadership. Top-ten concentration at the dot-com peak reached 37.0%; today it stands at roughly 40%. The fourth episode, today’s AI-and-Mag-7 configuration, has not yet resolved. An allocator who treats the current setup as permanent is implicitly betting that this time is different, despite repeated historical evidence.
 

Why small caps matter through the cycle, not just at the turn

Small caps earn a place in the policy mix on three grounds independent of timing the next rotation.

1. Breadth of opportunity.
   The small-cap universe is where most listed companies actually live, offering diversified factor and theme exposure that a mega-cap-dominated large-cap book does not provide. Further, the sector composition is materially different from large caps; US small caps carry more industrials, financials and real estate than US large caps, against an underweight in technology.
2. Direct, undiluted exposure to the themes that matter.
   Reshoring, European fiscal expansion, defence, grid and AI-infrastructure build-out and Japanese corporate reform all get expressed more purely through small caps than through the large-cap index, because the pure-play, picks-and-shovels companies in these themes are typically not listed at large-cap market capitalizations.
3. Differentiated economic exposure.
   According to research by Kepler Cheuvreux, European small caps generate roughly 60% of revenues from within Europe, versus roughly 33% for the blue-chip 50. This domestic tilt has become a feature rather than a bug in a world of recurring trade frictions, and the pattern broadly extends across EAFE.Bloomberg data indicate that Japanese small caps generate roughly 65–75% of their revenues domestically, compared with about 45% for TOPIX large caps. That domestic exposure leaves them well positioned to benefit from the emerging global order.

Unexpected outperformance: How are small caps doing it?

The cyclical setup we identified previously – technological disruption, top-of-market concentration, valuations well above long-run averages – remains in place. The conditions since end-February 2026 have been textbook unfavourable for small caps. Per Kepler, European front-end rate expectations re-priced sharply higher, eurozone economic surprises turned deeply negative, and oil spiked before partially retracing. Kepler’s analysis of monthly relative returns since 1994 shows European small caps have, on average, underperformed large caps by roughly -0.29% per month in OECD-defined « downturn » phases and -0.43% per month in « slowdown » phases. That headwind has not materialized.

And yet, small caps are outperforming large caps. Two features of the outperformance are worth flagging:

1. Outperformance has been broad-based across sectors rather than carried by a narrow theme: Kepler’s sector-level data since February 27, 2026 shows positive median small-cap performance against negative median large-cap performance, with European small caps outperforming large caps in nearly every sector.
2. Small caps’ historical sensitivity to bond yields has visibly weakened – per Kepler, the relative performance of European small caps versus large caps has materially decoupled from the German Bund yield since early 2025, breaking a relationship that had held for most of the post-2021 period.

The asset class is no longer waiting for rate cuts.

The valuation picture is the cleanest piece of the case. On Kepler’s data, European large caps trade at roughly 15.2x forward earnings against a long-term average since 2009 of 13.2x. European small caps trade at 14.4x against an average of 14.8x. The US picture is similar: BofA Global Research reports the relative forward P/E of the Russell 2000 versus the Russell 1000 is approximately 0.82x, and historically the relative forward P/E explains roughly 46% of the variability in subsequent 10-year relative returns.
 

Next week: turning the case into allocation

Small cap performance has been unexpected, but not entirely surprising. As investment managers specializing small caps, we know what small caps are capable of. Now that this market segment is regaining the attention of investors, what does this information mean for portfolio allocations? How can allocators adjust their underweight? We’ll discuss those details in next week’s commentary.

Global Alpha was founded on the conviction that small caps are an inefficient asset class in which an experienced team can generate alpha across a full cycle. We are happy to discuss how a small-cap allocation can be sized within a particular plan’s constraints, and how our Global and International Small Cap strategies have navigated the recent environment.

* Contact us for a copy of this article.

Last month, we wrote to investors about how the outperformance of EM equities was the product of a very narrow rally driven by a boom in South Korean and Taiwan tech companies. We noted that despite parabolic moves in semiconductor stocks, valuations have actually become cheaper due to a massive acceleration in earnings growth underpinned by rising US hyperscaler investment seeking to power frontier AI models.

In the weeks since, tech stocks continued to surge in feverish trading led by leveraged retail investors in South Korea. Jefferies Global Head of Equity Strategies, Chris Wood, flagged in early April that margin lending in South Korea had doubled from W15.8 trillion at the end of 2024 to an incredible W32.7 trillion this year.

Korea margin loan balance (Kospi + Kosdaq)

Source: Jefferies Global Equity, April 2026.

Investors also rushed to gain exposure through passive vehicles including leveraged ETFs.

 CSOP SK Hynix daily 2X leveraged product

Source: Bloomberg

Among GEM managers, overweight positioning has been steadily rising since the beginning of 2025.

Source: NS Partners & EPFR (date to end-April 2026).

The only game in town

The acceleration in fundamentals for stocks in the AI supply chain has been so dramatic that it has swamped the broader EM investment universe. The economic drag created by the US–Iran conflict has hit markets with higher sensitivity to rising energy prices. As these markets weather the economic turbulence, AI looks increasingly like the only game in town. In response, many investors have sold down areas hit by these tailwinds to fund larger weightings in AI-exposed names.

This shift in allocation resembles Charlie Munger’s “Lollapalooza Effect,” where extreme, disproportionate outcomes arise when multiple cognitive biases and incentives converge and reinforce each other simultaneously. In this case, a shift by investors, attracted by a sharp acceleration in fundamentals, has been magnified by systematic strategies, passives and leverage chasing the momentum. As a result, the IT sector now accounts for over 40% of the benchmark.

Source: NS Partners & LSEG Datastream.

Deteriorating monetary backdrop another source of fragility

Our Chief Economist, Simon Ward, has been writing about a global monetary squeeze which began in the months leading up to Gulf War III. This was exacerbated by the war sending commodity prices and CPI momentum higher, leading to a slowdown in real money growth.

Deterioration in real money growth due to high CPI momentum

Source: Money Moves Markets, May 2026.

Nominal money expansion to counteract the liquidity squeeze is unlikely in the near term, with most major central banks now making more hawkish noises in response to price pressures. This means less liquidity support for markets, especially in pockets which have run hard such as semiconductors.

Broken story or a reset in overbought technicals?

In early June, crowded positioning and an itch to take profits collided with rising macro uncertainty arising from the release of strong US payroll data which topped market forecasts, igniting fears the US Federal Reserve would be forced into tightening monetary policy. It is also possible that forthcoming blockbuster IPOs of SpaceX, OpenAI and Anthropic placing a strain on market liquidity further unsettled investors sitting on large gains. This culminated in a sharp selloff on the 5^th of June, with winning trades in the tech sector suffering the most.

Source: Bloomberg data

Behavioural discipline

As noted in last month’s commentary, Rallying EM equities reflect an AI-powered earnings surge, we had been trimming AI exposure into strength on a view that parabolic stock moves would inevitably run into a pullback. We have also been re-allocating within our IT exposure (a modest c.3% overweight as at the end of May), from companies where stock performance risks becoming detached from reality and into niches benefiting from the same demand drivers but where investor enthusiasm has not been so frenzied.

Over the past few years, we have worked to sweat our risk budget within the AI-supply chain, tweaking the portfolio as data and conviction changes by rotating through a number of segments outlined below.

AI exposure across layers

Source: NS Partners, June 2026.

The aim of this activity is to maximise risk-adjusted returns by maintaining a healthy exposure to AI supply chain companies, but in an allocation that is cheaper, less crowded, more positively skewed and with more independent catalysts than a static allocation to the original winners.

Global manufacturing PMI new orders edged down in May from April’s four-year-plus high. The expectation here has been for a further decline in H2, reflecting a slowdown in global six-month real narrow money momentum from a February peak – see previous post.

Two recent releases support this forecast. First, one-month growth of the OECD’s G7 leading indicator fell again in May. Growth peaked in December and has led PMI new orders by three months on average historically, suggesting that April’s orders high will prove lasting – see chart 1.

Chart 1

Secondly, the PMI stocks of purchases index indicates that stockpiling of inputs accelerated further last month, likely marking a cycle peak – chart 2.

Chart 2

Growth in new orders is related to the rate of change of stockbuilding, implying a slowdown even in the unlikely event that the stocks of purchases index remains at its current extended level – chart 3.

Chart 3

AI infrastructure investment has moved upstream. The advent of ChatGPT, Claude and other AI applications fueled demand for semiconductor chips that enable the software to “think.” The demand concurrently brought about record capital expenditures to build out hyperscale data centres housing those chips. Now the bottleneck is even more basic: power. For AI, electricity is no longer a utility input; it is strategic infrastructure.

Data centre growth needs energy – a lot of it

That shift is colliding with a US grid whose expansion is constrained at multiple points: new generators are stuck in interconnection queues; interstate transmission still requires approvals across multiple jurisdictions; transformer shortages are delaying grid upgrades; and local opposition is increasingly slowing or cancelling data centre projects. North American Electric Reliability Corporation’s 2025 long-term reliability assessment warned that 13 of 23 North American assessment areas face resource-adequacy challenges over the next decade, underscoring that the issue is not only energy volume, but deliverability and reliability.

Electric Power Research Institute’s Powering Intelligence 2026 report makes the same point from the data centre side. Its “Generation and Capacity Impacts of Data Center Load” analysis finds that data centre growth could require large additions of generation and transmission capacity, but that supply-chain, siting and permitting constraints may limit how fast those additions arrive. In least-cost scenarios, incremental data centre load is met primarily by new and existing gas generation rather than carbon-free resources.

Getting power to where it’s hard to get

That naturally explains the recent order flow into large reciprocating engines. In April, the Finnish vessel engine manufacturer Wärtsilä Oyj Abp announced a 790 MW off-grid power solution for a new Texas data centre facility, using its 50SG natural gas engines. Wärtsilä explicitly framed the order around fast access to reliable power in a region where the grid cannot adequately meet urgent AI-infrastructure demand. Around the same time, the Korean shipbuilder HD Hyundai Heavy Industries Co. Ltd. disclosed that it had signed a US data centre power generation equipment contract based on its 20 MW-class HiMSEN engines, citing total capacity of 684 MW.

The appeal is straightforward. Large reciprocating engines are modular, dispatchable, fast-starting, scalable in increments and deployable closer to load than central-station plants. Compared with combined-cycle gas turbines, nuclear projects or major transmission upgrades, they can often be installed in shorter phases and avoid waiting years for grid interconnection. For a data centre developer, speed-to-power can be as important as cost-of-power.

Maintaining engine power at sea and on land

HD Hyundai Marine Solution Co. Ltd. (443060 KS) in our Emerging Markets Small Cap Strategy is the sole authorized provider of maintenance, repair and overhaul (MRO) aftermarket services to HiMSEN engines worldwide. As a HD Hyundai-affiliate, the company benefits from having HD Hyundai Heavy Industries – the world’s second largest shipbuilder and the largest manufacturer of medium-speed 4-stroke vessel engines – as a captive market. Of approximately 17,000 HiMSEN units in operation globally (most of them generating power for over 4,000 ships at sea), roughly 2,000 units are generating power on the ground.

Could data centres move offshore?

Mitsui O.S.K. Lines and Karpowership’s Kinetics have already signed a memorandum of understanding to develop what they describe as the world’s first integrated floating data centre platform, hosted on a retrofitted vessel and supplied by a powership capable of using LNG. In that scenario, vessel-engine makers are also powering the physical layer of AI.

La société Crestpoint Real Estate Investments est heureuse de poursuivre son partenariat avec Vestcor et Anthem Properties dans le cadre du projet d’envergure King + Park, un immeuble à usage mixte à la frontière de Burnaby. En compagnie du maire de Burnaby et d’autres invités, Crestpoint, Vestcor et Anthem ont pris part à la cérémonie d’inauguration des travaux du projet le 1er juin 2026.

Situé dans un milieu axé sur le transport en commun, le projet complet de King + Park comprend :

• 724 logements locatifs dans deux tours sur un même socle (la phase 1 est en cours de construction)
• Restauration de l’emblématique Boot Office Tower
• 512 350 pieds carrés de locaux à bureaux conservés et restaurés (Boot)
• 43 402 pieds carrés d’espaces commerciaux livrés à toutes les phases
• 1 559 logements en copropriété divise (phase future)

Comme l’a souligné Max Rosenfeld, vice-président exécutif et chef de la gestion des biens à Crestpoint, King + Park est « à la fois une occasion unique d’honorer le patrimoine et de réinventer un site », et Crestpoint est ravie de prendre part à un projet qui aura un impact positif et durable.

Three-month annualised growth of Eurozone narrow money – as measured by non-financial M1 – slumped from 5.3% to 1.5% between January and April. UK growth fell from 3.8% to 0.7% over the same period, with a large contraction in April alone.

The nominal slowdowns compound a squeeze on real money from consumer price acceleration due to the Gulf War III supply shock. Six-month momentum of real narrow money fell to zero in the UK in April while turning negative in the Eurozone – see chart 1.

Chart 1

Real money contractions have been a recession warning signal historically. An obvious push-back is that much greater weakness in 2022-23 was not reflected in a subsequent economic slump. Negative momentum was a misleading indicator of monetary conditions then because of a large overhang from the 2020-21 money growth surge. There is no such overhang now, so dismissing current weakness on the basis of that experience is dangerous.

Broad money trends are also worrying, with nominal growth of only 3.5% and 3.6% annualised respectively in Eurozone non-financial M3 and UK non-financial M4 in the three months to April. US broad money, by contrast, expanded at a 7.6% pace over the same period (M2+ measure).

Globally, six-month real narrow money momentum fell for a second month in April, supporting the forecast of a fall in manufacturing PMI new orders during H2 – chart 2.

Chart 2

Les marchés boursiers ont continué d’atteindre de nouveaux sommets malgré un contexte qui, à première vue, devrait être beaucoup moins favorable. La guerre au Moyen-Orient, les prix élevés du pétrole, le resserrement des conditions financières et l’incertitude entourant les politiques n’ont pas fait dérailler l’appétit pour le risque. Il y a eu des périodes de volatilité en cours de route, mais aucune n’a considérablement perturbé la tendance générale à la hausse. Au lieu de cela, les actions se sont redressées, les marchés du crédit sont demeurés solides et les investisseurs ont, à maintes reprises, ignoré les chocs qui, au cours des cycles précédents, ont peut-être déclenché une réévaluation plus importante.

Les moteurs de la remontée

La vigueur des marchés boursiers est attribuable à l’alignement de deux forces exceptionnellement puissantes et concentrées.

La première étant le cycle d’investissement alimenté par l’IA, qui se démarque non seulement par l’ampleur du cycle des dépenses en immobilisations (graphique 1), mais aussi par sa structure. Les investissements sont stimulés par un petit groupe de fournisseurs de services infonuagiques à très grande échelle qui engagent des sommes sans précédent dans des centres de données et des infrastructures de soutien qui, selon certaines estimations, pourraient atteindre 5 000 G$ US au cours des cinq prochaines années; de plus en plus, les sociétés tirent parti des marchés mondiaux du crédit pour financer ces investissements. Les marchés du crédit, en particulier, n’agissent pas comme une contrainte. Les fortes émissions ont été facilement absorbées, la solide demande maintenant les écarts de taux serrés, même si l’offre augmente. Au Canada, la première émission d’obligations feuille d’érable d’Alphabet a atteint un niveau record de 8,5 G$ CA et a été très bien absorbée. En fait, les conditions de financement favorisent l’expansion économique au lieu de la limiter.

Graphique 1 : Les investissements dans les technologies ont bondi aux États-Unis
Source : US Bureau of Economic Analysis et Macrobond.

Parallèlement, les bénéfices des sociétés ont été manifestement solides. L’indice S&P 500 est en voie d’enregistrer une croissance des bénéfices d’environ 28 % sur 12 mois au premier trimestre, soit le rythme le plus rapide depuis 2021. Plus important encore, cette vigueur a été généralisée. Dix secteurs ont annoncé une croissance de leurs bénéfices, sept secteurs ayant enregistré des gains de plus de 10 %, notamment les technologies de l’information, la finance, l’industrie et les matériaux (graphique 2).

Graphique 2 : La croissance des bénéfices aux États-Unis est solide et généralisée
Source : FactSet. Remarque : Au 21 mai 2026.

Bien que les bénéfices soient généralisés, un groupe relativement petit de sociétés d’IA et liées à l’IA dicte les révisions, l’humeur et la répartition du capital. Pourtant, malgré l’ampleur des investissements, la contribution directe à la croissance du PIB demeure limitée. Ce qui rend le contexte actuel inhabituel, c’est que la remontée n’est pas purement spéculative, car les bénéfices sont élevés. Tant que la résilience généralisée des bénéfices se poursuivra parallèlement à un moteur concentré de croissance, la trajectoire vers le haut peut rester inchangée.

Disparition des risques de baisse

Si le moteur explique l’orientation des marchés, la persistance de la remontée reflète le fait que les risques ne se sont pas matérialisés à plusieurs reprises. La situation géopolitique est l’exemple le plus évident, les perturbations dans le détroit d’Ormuz ayant fait grimper les prix du pétrole de façon importante, mais pas à des niveaux compatibles avec l’ampleur du choc. Par ailleurs, d’autres risques macroéconomiques sont largement ignorés. Les marchés de l’emploi continuent de ralentir, mais ils semblent avoir touché un plancher, de sorte que la croissance de l’emploi et des revenus demeure suffisante pour soutenir la consommation.

Fait important, l’inflation s’est révélée persistante. En avril, les prix à la production aux États-Unis ont fortement augmenté, l’IPP global ayant progressé de 1,4 % sur un mois, en raison de la forte hausse des composantes liées à l’énergie. Sous la surface, toutefois, la situation semble modérée. Les prix des biens de consommation de base indiqués dans le rapport d’avril sur l’IPC ont fait du surplace pendant le mois, et les prix des services de base, bien que toujours élevés, n’ont pas beaucoup augmenté (graphique 3). De plus, le mécanisme de transmission semble plus faible que lors des cycles précédents, y compris la période après la pandémie, lorsque les hausses rapides des salaires et les politiques budgétaires et monétaires très expansionnistes ont renforcé l’inflation à l’échelle de l’économie.

Graphique 3 : Les prix des services de base sont relativement contenus
Source : US Bureau of Labor Statistics et Macrobond.

Les marchés n’ignorent pas les risques – ils observent que ces risques ne se traduisent pas par des bénéfices négatifs ou une croissance négative, et s’ajustent en conséquence. Chaque fois que le risque passe inaperçu, les marchés deviennent enclins à faire abstraction des chocs. Les préoccupations s’estompent plus rapidement et le positionnement se reconstruit plus rapidement.

Qu’est-ce qui pourrait briser cet optimisme à l’égard du risque?

Les taux obligataires ont augmenté, les taux à court terme ayant fortement grimpé et les courbes de taux s’aplatissant, une combinaison habituellement associée au resserrement des conditions financières. Depuis le début du conflit, les taux des obligations américaines à 10 ans ont augmenté considérablement, et les taux des obligations à 30 ans ont dépassé le seuil psychologiquement important de 5 %. Les taux à court terme ont augmenté encore plus fortement, en raison des pressions inflationnistes et de la résilience de la croissance. Par ailleurs, les actifs risqués ont continué de se redresser parallèlement à cette hausse, une dynamique inhabituelle de fin de cycle qui fait en sorte que le système se dirige vers des taux d’intérêt toujours plus élevés. Fait intéressant, les mêmes forces qui soutiennent les actifs risqués contribuent également à ce resserrement. Le cycle d’investissement alimenté par l’IA soutient la demande, renforce les pressions inflationnistes (graphique 4) et fait en sorte que la politique monétaire est plus restrictive que ce que les marchés auraient pu prévoir. En ce sens, l’optimisme qui alimente la remontée est également ce qui empêche l’assouplissement de la politique monétaire.

Graphique 4 : Les pressions inflationnistes à court terme s’intensifient
Source : US Bureau of Labor Statistics et Macrobond.

Cela crée des tensions croissantes. Dans le passé, la hausse des taux d’actualisation et le resserrement des conditions financières ont pesé sur les valorisations boursières. La politique monétaire ajoute une autre couche d’incertitude. Les banques centrales délaissent l’assouplissement monétaire, en raison des risques croissants d’inflation. Elles craignent que les attentes d’inflation ne soient plus ancrées dans leurs niveaux cibles si le choc étroit des prix des matières premières se traduit par une réaccélération de l’inflation de base (même si l’on suppose actuellement que les perturbations énergétiques sont temporaires et gérables). De plus, aux États-Unis, la transition vers un nouveau président de la Réserve fédérale crée une autre incertitude qui pourrait renverser la souplesse du régime précédent.

Stratégie de portefeuille

Dans les portefeuilles équilibrés, les actions et les titres à revenu fixe demeurent légèrement sous-pondérés. Cette position a été mise en œuvre à la fin du premier trimestre, lorsque les marchés sont entrés dans une phase de « choc inflationniste d’abord, puis risque de croissance plus tard ». Les risques de récession se sont depuis atténués, de sorte que les actions se négocient maintenant près de sommets historiques, intégrant des hypothèses de croissance relativement optimistes. Par conséquent, la patience et la souplesse demeurent importantes. Nous cherchons à accroître le risque de façon opportuniste en périodes de faiblesse des marchés ou de ventes massives attribuables au positionnement. Nous privilégions les actions canadiennes par rapport aux actions américaines, et nous sommes optimistes à long terme à l’égard du Canada.

Dans les portefeuilles de titres à revenu fixe, la conjoncture demeure difficile, car la forte croissance, l’inflation persistante et la hausse des prix de l’énergie continuent d’exercer des pressions à la hausse sur les taux obligataires. Les marchés ont constamment revu à la baisse leurs attentes à l’égard des réductions de taux d’intérêt et ont commencé à anticiper la possibilité de hausses des taux directeurs au Canada et aux États-Unis. Par conséquent, la courbe des taux s’est aplatie et les taux ont augmenté. Cette tendance devrait se poursuivre, mais pas de façon linéaire. La durée continuera d’être gérée de façon tactique, mais sera de préférence plus courte que celle de l’indice de référence, avec un accent sur la souplesse plutôt que sur d’importantes positions directionnelles.

Les portefeuilles d’actions fondamentales continuent d’investir dans des sociétés affichant des bénéfices résilients. Bien que la reprise dans son ensemble demeure intacte, nous avons interrompu l’augmentation des placements cycliques afin d’atténuer le risque de baisse. Nous avons également réduit la pondération des modèles d’affaires les plus vulnérables aux perturbations causées par l’IA, tout en augmentant de façon sélective la pondération des secteurs qui sont positionnés de manière à profiter du cycle plus large des dépenses en immobilisations et des infrastructures liées à l’IA, y compris les secteurs liés aux matières premières.

Le contexte actuel continue de privilégier une approche opportuniste, et nous cherchons à accroître le risque avec prudence.

New orders reached a four-plus-year high in April but DM flash results imply a pull-back in May. The forecast here is for a further decline in H2, reflecting an inflation-driven slowdown in global six-month real narrow money momentum from a February peak – see chart 1.

Chart 1

A further consideration is that orders have been boosted recently by demand front-loading and stockbuilding motivated by supply concerns, implying future payback.

PMI new orders are contemporaneously correlated with MSCI World earnings revisions, whether expressed in terms of the revisions ratio (net proportion of analyst estimates upgraded each month) or the one-month percentage change in aggregate forecast earnings per share – chart 2.

Chart 2

Both revisions measures remained strong in May but the expected new orders decline suggests a moderation, at least, ahead.

Current earnings strength is focused on the US and AI-spend beneficiaries, with downgrades in Europe, China and EM ex. Korea / Taiwan – chart 3. The suggestion of European relative weakness was echoed in the flash PMIs.

Chart 3

Sector wise, IT extended its lead, with consumer sectors continuing to suffer earnings downgrades – chart 4. The revisions ratio gaps between IT and consumer discretionary / staples reached new records in data extending back to 1995 – another manifestation of economic disparities.

Chart 4

China’s semiconductor ambitions returned to the spotlight following the recent meeting between President Trump and President Xi. While the US administration reportedly signaled willingness to permit exports of certain downgraded or older-generation AI GPUs into China, the more notable takeaway may have been China’s relatively muted reaction. Rather than relying on controlled access to foreign technology, China appears increasingly focused on accelerating the development of its own semiconductor ecosystem.

While the AI cycle continues to demonstrate remarkable strength, China’s push toward semiconductor self-reliance increasingly appears to represent an additional structural driver for the industry – one that could persist largely independent of the pace or duration of the current AI infrastructure cycle.

A focus on a domestic opportunity for self-reliance

The scale of the opportunity remains significant. China is already the world’s largest semiconductor consumption market, representing well over USD200 billion of annual chip demand and likely continuing to grow meaningfully over the coming decade. Yet domestic self-sufficiency across many semiconductor categories remains relatively low, leaving substantial room for domestic substitution over time. Even within analog and power semiconductors – categories generally viewed as more achievable for domestic suppliers – the opportunity remains large. Industry estimates suggest China’s power management semiconductor demand alone already represents a multi-billion-dollar market, while domestic suppliers still account for a relatively modest share. If China materially increases domestic semiconductor content over the coming years, tens of billions of dollars of annual value could gradually shift toward Chinese suppliers.

China still faces important technological bottlenecks. Advanced EUV lithography remains effectively inaccessible, while gaps persist across certain leading-edge manufacturing equipment, inspection and metrology tools and advanced materials. However, recent developments suggest China continues to make incremental progress across multiple parts of the semiconductor stack despite these restrictions. Domestic memory players have advanced meaningfully in NAND and DRAM, while progress in high-bandwidth memory (HBM), advanced packaging and other areas continues to evolve. More broadly, as the saying goes, necessity is often the mother of invention, and technological constraints themselves can become catalysts for accelerated domestic innovation.

Lessons from solar, batteries and EVs

Importantly, China has already demonstrated an ability to achieve global scale and competitiveness in industries once dominated by foreign incumbents. The country now holds leading positions across solar panels, batteries and electric vehicles, while also becoming increasingly competitive in industrial automation and advanced manufacturing more broadly. Regardless of one’s geopolitical perspective, China’s long-term willingness to commit capital, engineering talent and policy support toward strategic industries should not be underestimated.

As the AI infrastructure cycle evolves, bottlenecks have gradually expanded beyond AI accelerators and memory into broader areas of the semiconductor supply chain. More recently, power management integrated circuits (PMICs) have emerged as an area experiencing tighter supply-demand dynamics, driven by rising demand from data centres and AI infrastructure. AI servers require increasingly sophisticated power architectures, translating into higher semiconductor content and more advanced PMIC requirements. These products typically command higher pricing and more attractive margins, while stronger AI-related demand may also help stabilize pricing conditions across broader analog semiconductor markets.

Against this backdrop, we believe companies positioned within China’s domestic semiconductor ecosystem could benefit from these longer-term trends. One example within our Emerging Markets portfolio is Silergy Corp. (6415 TT), a China-based analog semiconductor company and one of China’s leading domestic suppliers of PMICs.

Why PMICs are important

PMICs are semiconductors responsible for regulating and distributing electrical power within electronic systems, helping ensure that processors, servers, vehicles and industrial equipment receive power efficiently, reliably and safely. Unlike leading-edge AI accelerators, analog and power management semiconductors are embedded across a broad range of everyday electronic applications.

Headquartered in Hangzhou, Silergy designs analog and mixed-signal semiconductors serving industrial, automotive, consumer electronics, computing and communications applications. While the company is gaining increasing exposure to AI servers and data-centre-related applications, its business remains diversified across multiple end markets, which in our view provides a more balanced way to participate in both semiconductor self-reliance and broader electronics content growth.

Silergy is already one of China’s leading domestic PMIC suppliers, yet its market share within China’s broader analog and power semiconductor market likely remains relatively small, suggesting a potentially long runway for continued share gains over time.

While market attention remains concentrated on the most visible AI beneficiaries, some of the more durable investment opportunities may emerge deeper within the semiconductor supply chain and away from the headlines. China’s semiconductor ambitions could ultimately prove to be one of the more important long-term trends still unfolding beneath the surface of today’s AI cycle.

Emerging market equities have outperformed the rest of the world year to date.

Source: NS Partners and LSEG Datastream

The asset class is decisively breaking out of a long-run trend of underperforming developed markets.

Source: Bank of America, May 2026.

What is driving the turnaround? Looking at contributions to returns since 2023, earnings have been the clear driver for emerging market equities, with multiple expansion only a minor contributor.

Source: Jefferies quant research, April 2026.

Earnings growth has been the key driver

Source: NS Partners and LSEG Datastream.

In fact, for the year to date as at the end of April, valuation compression has been a headwind for the asset class.

Source: Jefferies quant research, April 2026.

EM equities are now cheaper than they were in beginning of 2025 despite strong returns.

Source: NS Partners and LSEG Datastream.

We flagged in previous pieces that the signals we track suggested emerging market equities were positioned to outperform their developed market counterparts. Based on the headline numbers it appears this call has been vindicated (albeit over a short period) with the welcome combination of cheaper valuations and a strengthening earnings outlook.

What got us particularly excited was the potential for a US dollar bear market driving a new virtuous circle, as illustrated below.

We have had positive spurts in a number of markets which enjoyed easing currency pressure courtesy of a falling dollar and better liquidity. However, this has been overwhelmed by the US AI boom which is bleeding out into emerging markets with North Asia the clear winner.

It has been a narrow rally driven by US capex and the AI supply chain

This dramatic improvement in earnings and performance largely reflects a boom in South Korean and Taiwan tech companies. If you strip these markets out of EM, the return picture for the wider asset class is subdued.

YTD outperformance of EM equities has been entirely due to Korea/Taiwan, with the rest of the asset class lagging DM

Source: NS Partners and LSEG Datastream

The demand boom for key technologies that underpin the infrastructure needed to meet a massive build out of AI technologies and the flow through to earnings growth is swamping interest in other positive stories across the asset class.

We are modestly overweight AI supply chain leaders in South Korea and Taiwan, who control key supply bottlenecks across memory and logic chips, thermal cooling, signals and switching, electrification and data centre assembly. Earnings growth and margins for these companies are downstream of rising investment from US hyperscalers seeking vast amounts of compute power to develop cutting-edge large language models.

Source: Koyfin, April 2026.

Portfolio names in these areas have posted outstanding gains over the last 12 months. While we have been quick to trim positions when stock valuations exceed what we think is reasonable, we have not run away from the rally and have maintained the overweight as we can see the fundamentals accelerating. For example, the supply-demand mismatch for high bandwidth memory is so great that memory giants SK Hynix and Samsung Electronics are now among the most profitable companies in the world.

Source: Jefferies March 2026.

Earnings growth in South Korea has been so strong that valuations still look modest despite the market doubling

Samsung Electronics, Hynix and Micron are the only three companies in the world capable of producing HBM chips that are crucial components in Nvidia GPU clusters. And yet, Samsung and Hynix trade at a price to earnings multiples of less than 5x.

Source: Deutsche Bank 2026.

Optically, cheap valuations reflect a market view that these remain deeply cyclical businesses in an industry with a history of violent booms and busts and thus lack the durability in the earnings growth to award a higher multiple.

Looking at the table above, there may be a good argument that the DRAM giants are over-earning and will attract competitors. On the other hand, we are mindful that AI innovation represents a major technological shift and the possibility that this could structurally alter demand dynamics in an oligopolistic industry controlling essential and hard to replicate technologies.

Maintaining conviction with tight risk management

While the pace of capex spending by the US hyperscalers and the cash flows going to hardware suppliers is extraordinary, the parabolic stock moves in a number of the names that we hold naturally make us twitchy. Major uncertainty remains over how LLM technologies will evolve and be monetised, whether competitor frameworks will gain dominance, and if real-world bottlenecks in memory and energy may ultimately slow the pace of development.

We have been careful to trim winners and recycle profits elsewhere in emerging markets where we are seeing other opportunities that excite us. Equally, relatively modest valuations and earnings visibility on our time horizon represent a significant upside risk which leaves us happy to maintain our overweight to the AI supply chain.