We’ve hashed out the arguments for a persistently slowing China in this blog many times, so we won’t go there again today. Instead, we want to focus on a different aspect of the slowing China reality: the fact that most investment products that focus on emerging markets are overweight exactly the wrong economic sectors. In the scenario of a slowing and rebalancing China, the areas of the economy that are likely to benefit the most are different from the areas that gained from the infrastructure build out since 2000.
Between 2000-2011 it was a great time to be a raw materials producer, seller of industrial machinery, or a bank that lent money to governments and businesses engaged in Great Chinese Infrastructure Boom. From 2011 through today, it has not been so great and the unfortunate reality for companies like this is that the China slowing/rebalancing story has got years left to play out. This means a continued slowing of demand for many companies in the energy, financials, industrials, materials, utility and telecom spaces.
On the other side of the coin are the consumer oriented areas of the economy like consumer staples, discretionary and health care companies that are poised to see increasing revenue as growth in consumption remains strong or even picks up pace.
As the chart below shows, the obvious problem from an investment perspective is that currently emerging market mutual funds in aggregate have about 53% of their exposure to the slow growth areas and only 47% of their exposure to the relatively faster growth areas. Under normal circumstances this may not be such a large problem, but when we see the potential of a decade of slowing/rebalancing of the Chinese economy ahead of us this makes us wonder whether the funds in the EM space are allocated differently enough from their benchmark to produce adequate returns going forward.