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China Weighs on Emerging Markets Indexes

China Weighs on Emerging Markets Indexes

August 06, 2021
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China’s stock exchanges have been hit hard in response to several sudden regulatory actions that have dismayed investors. First came the crackdown on ride sharing service DiDi, which has about a 90% market share in China. Regulators had announced a cybersecurity review soon after its initial public offering on the New York Stock Exchange, eventually ordering the removal of DiDi from app stores. Then there were fines against tech giants Alibaba and Tencent. Next came an announcement that for-profit tutoring services would no longer be able to charge for certain core classes. The rapid sequence of government action against publicly traded companies has shaken market participants, with Chinese indexes and related stocks down significantly.

The issues in China also mean problems for investors in diversified emerging market equities. China has by far the largest weight in the MSCI Emerging Markets Index, at 35%, down from more than 40% prior to the recent sell-off. MSCI and other index providers have steadily increased their exposure to Chinese equities in emerging market indexes in recent years, a seemingly active decision that may surprise so-called passive investors.

As shown in the LPL Chart of the Day, China weighing down broad emerging markets is not exactly a new trend. While China outperformed other emerging markets (EM) amid the early stages of the COVID-19 pandemic, as global markets have recovered, a basket of emerging market equities that excludes China has strongly outperformed the MSCI China Index going back to last year.

See enlarged chart.

“Chinese officials have more recently taken a conciliatory tone to try and settle markets back down,” said LPL Financial Chief Market Strategist Ryan Detrick. “However, broken trust is not easily restored and technical damage will take time to repair. How China continues to respond will be important for investors to watch in August.”

We preview more things investors should know heading into August in next week’s Weekly Market Commentary. For now, we recommend that investors recognize that while China could bounce, alpha opportunities might lie elsewhere in 2021. In addition, we believe traditional active management makes the most sense for EM exposure, allowing experts to assess risk and reward for regions and companies rather than defaulting to market cap-weighted indexes.

 

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