China’s regulatory drive and shift in policy to focus more on “common prosperity” has roiled markets and left some investors questioning whether they need any China allocation at all. Global strategist Ruchir Sharma thinks ignoring China isn’t much of an option for global investors, but he isn’t that interested in bargain-hunting among the fallen internet titans and is worried about the risks from the crackdown on the global economy.
Barron’s caught up with the veteran globetrotter, who is chief global strategist for Morgan Stanley Investment Management, to talk about whether the 35% China weighting in emerging market indexes is too high and why investors shouldn’t lump China into the same market as countries like Russia or Korea that trade at a discount due to political and governance concerns.
Barron’s: Are we in the midst of a sea change in China?
Ruchir Sharma: It’s too early to say. You had this unregulated, Wild West of capitalism in the technology sector; in 2020, China had more new billionaires than any other country in the world. Now, they are regulating it. The regulation doesn’t have a framework you can latch on to. It’s disorienting, but I don’t know if this is a sea change.
What is the risk of the crackdown on large technology companies?
This is the golden goose for their economy—40% of their economy is from the digital economy, the highest [share] in the world. People underestimate how much of a technology-oriented economy China has become. The risks [of regulation] are greater this time because China is so dependent on technology and, at the same time, it is also cracking down on the property sector, which accounts for another 20% to 25% of the economy. It doesn’t bode well for the global economy, or China, which is my bigger concern. People haven’t focused as much on that.
Should China trade at a discount because of the increased risk of political or governance risk, like Russia and Korea do?
We are in the midst of a regulatory cycle and these tend to last a year or so, if the past is any guide. The sectors they are targeting are the ones you want to stay away from. But it’s very different from Russia or Korea because of the size of this economy.
It’s still the second-largest economy in the world. A year ago, it was, ‘You can’t get enough China exposure.’ Now, it’s: ‘Do we need any?’ The truth is it’s always been in the middle. To swing from one extreme to another for such a large economy is not a view that investors can afford.
Your funds have been underweight China. Why?
A combination of valuations, regulatory risks and opportunities elsewhere. Even after the underperformance, 35% of the MSCI Emerging Markets index is in China. It was 40% before. For an emerging markets investor to allocate this much to China—that is something you need to think about. The risk assessment of China got clouded because [investors] made so much money in Chinese tech over the last few years; the risk in absolute terms is overlooked.
How should investors approach their China investments?
You have to be very careful, at least for the next few months. I don’t think it’s in their interest to kill the [big internet] companies, but I’m more inclined to allocate to other companies rather than look for the bottoms of these [big technology] companies that have had an amazing run in the last 10 years. There’s risk to megacap tech everywhere [from regulation]. I’m interested in finding new companies.
Where are those new companies?
The trend of digitization in emerging markets is here to stay. Companies like
[MELI] both recently had strong results. In China, there are two risks: You already had a massive run-up and the regulatory risk. I’m happier allocating to the same digitization trend at earlier stages in India, southeast Asia and Eastern Europe that are at an earlier stage of the curve than China.
Where else within emerging markets do you see opportunities?
I’m more bullish on commodities because they have had so much underinvestment. That’s good for Latin America, Africa and Russia. They have such small weights in the index. Mexico and Indonesia are less than 2%—and it’s not that these economies are small!
Write to Reshma Kapadia at firstname.lastname@example.org