BlackRock vs Soros on China: Which view should investors believe?
China’s transformation from a backward economy in the early 1980s to an economic and financial superpower today stands out as one of the most remarkable achievements in history. The origins can be traced to structural reforms Deng Xiaoping introduced to utilize market forces to shift China’s economy away from reliance on inefficient state-owned enterprises (SOEs).
Deng’s successors continued the process of economic reform until the Global Financial Crisis hit in 2008. Thereafter, China’s leaders began to rethink whether it was prudent to follow the model of western economies.
When Xi Jinping became China’s leader in 2012, he initially paid lip service to the reform process. But Xi was primarily interested in bolstering SOEs. In a 2019 book, Nicholas Lardy of the Peterson Institute documented how China’s private sector was significantly diminished over the previous decade.
Foreign investors seemed oblivious to what was happening until July of this year, when they became concerned about the government’s clampdown on tech businesses and companies that raise capital offshore. Several leading technology companies lost about 20 percent of their market capitalization in the month. Thereafter, the sell-off steepened when the government confirmed it would take strong actions to restrain the country’s booming after-school tutoring industry.
In the wake of these developments, commentators on China have split into two camps.
The benign view is the recent regulatory clampdown is not unusual and the tech giants, which have a history of adapting to new regulatory regimes, will be able to cope with the latest set of rules. A leading proponent is BlackRock, which issued a report recommending that investors should triple their allocations in Chinese assets.
BlackRock’s argument is that China, the world’s second-largest economy, should no longer be considered an emerging market. Over time, BlackRock believes an increased allocation to China will boost returns and provide diversification benefits that compensate investors for heightened uncertainty today.
A more ominous view is that China’s regulatory clampdown could signal the end of the country’s economic miracle. A leading proponent is George Soros. The headline of a recent op-ed Soros wrote for the Financial Times was “Investors in Xi’s China Face a Rude Awakening.” He argues that Xi does not understand how markets operate and that the crackdown by the Chinese government is real.
Soros also notes that many pension fund managers allocate assets so they are closely aligned with their benchmarks. As an example, he cites that one third of BlackRock’s ESG Aware emerging market fund represent investments in Chinese companies. Soros concludes that Congress should pass a bipartisan bill requiring asset managers to invest only in companies where actual governance structures are transparent and aligned with stakeholders.
Given the extreme divergence in these views, investors face a challenge in deciding which one will be proven right. My advice is to keep three considerations in mind.
First, don’t rush to judgment. The issue of China’s future is extremely complex. One has to take into account both economic and political considerations that will unfold throughout this decade.
On the economic front, the prevailing view is that China’s growth is likely to slow on a secular basis in response to demographic trends and a slowdown in productivity growth. The new element is that the clampdown of businesses by the government could hurt entrepreneurship, which has been a key component of the Chinese miracle. Steve Roach, a self-described optimist on China, worries that this could disrupt it.
On the political front, some observers see the actions by Xi as a way for him to consolidate power ahead of the Communist Party’s congress in October 2022. With the Party already having approved the removal of a two-term limit on his presidency, Xi is seeking to become China’s leader for life. He is taking actions that will bolster support from workers and the disadvantaged.
As the Wall Street Journal observes, Xi is championing the slogan “common prosperity” as a way to address social inequities. Alibaba and other leading companies have pledged millions of dollars to support the effort to gain favor with the government.
Second, don’t brush the issue aside. While it is too early to know how these developments will play out, one thing is clear: the risk of investing in China has increased materially. As Nancy Lazar of Cornerstone Macro observed in a recent commentary, “Beijing’s new 5 year regulation program explicitly pinpoints companies with notable market share, significant social/political/investment control, useful data or consumer impact.”
Her bottom line is that the clampdown started with internet/tech giants, “but now the whole economy is on the table.” In short, the scale of what is happening is far greater than in the past.
Third, resist the temptation to gloat if China weakens. With the rivalry between the United States and China heating up, U.S. citizens may view weakness in China as a “win” for the U.S. This way of thinking was reinforced by President Trump’s rhetoric during the trade war with China, in which he viewed trade as a zero-sum game where if one party is better off the other must be worse off.
In fact, the global economy has been strongest when both the United States and China are preforming well and trade is expanding. If the Chinese economy were to slow materially in the next few years – say, to 3 percent or 4 percent per annum – it would have a marked impact on China’s main trading partners, notably Asia, the U.S. and Europe.
Consequently, a setback in China would likely spread worldwide and have adverse repercussions for the global economy and financial markets. For this reason, even those who do not invest in Chinese businesses cannot ignore this issue.
Nicholas Sargen, Ph.D., is an economic consultant and is affiliated with the University of Virginia’s Darden School of Business. He is the author of “Investing in the Trump Era; How Economic Policies Impact Financial Markets.”
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