About a decade ago, when investors were still enamored with emerging markets and the US, Ruchir Sharma hailed the US as the comeback nation, correctly forecasting the subsequent bull market. Today Sharma, president of Rockefeller International, the international arm of Rockefeller Capital Management, sees the best opportunities outside the US and China, the world’s two largest economies.
After working for 25 years in Morgan Stanley’s investment management business, most recently as head of global strategy, Sharma joined Rockefeller in February. The firm oversees $95 billion in client assets. Sharma is also launching a new investment firm, Breakout Capital, in partnership with Rockefeller, to focus on emerging markets and global asset allocation, his specialty.
Sharma recently spoke with Barron’s from Miami, one of his ports of call during the Covid pandemic, on the challenges facing businesses and investors in China, why he’s avoiding Chinese tech stocks like
Alibaba Group Exploitation (ticker: BABA) and global luxury companies, and why investors need to recalibrate their growth expectations. An edited version of the conversation follows.
Barron’s: How will the war in Ukraine affect the markets?
Ruchir Sharma: For now, [investors] assume it’s a sideshow, and a long, tiring war. It’s going to affect things in decimal points versus percentage points.
It doesn’t stress me out that China joins Russia and this turns into a third world war. China is much more entrenched in the Western financial system and cares about it much more than [Russia does]. That is a check and balance on China’s ability to act. China’s economy is also weak and worries about the economy.
Given China’s recent economic struggles and the fallout from its harsh Covid lockdowns, could Chinese leader Xi Jinping be denied a third term in the fall?
We have no idea. But China is deviating from one of its key successes in the last 40 years: they were very clear that no leader could serve more than two terms. That always brought renewal, a leadership upheaval. [Xi getting a third term] It is a big difference. I am much more concerned that the Chinese economy will become less robust over time.
The other concern is China’s debt path and the consequences of its debt-dependent growth over the past decade. Xi realizes [the debt problem]so it is trying to crack down on real estate. [Top economic adviser] Liu He becomes aware of the vulnerability that too much debt brings to the economy and how Chinese empires of the past have been brought down by debt. But every time they want to reduce debt, the economy slows down and they inject more debt.
Should foreign investors and companies continue to seek a foothold in China?
The emerging market that excites me the least is China. Everyone needs to think about how to diversify outside of China. The risk is not so much that China joins the war with Russia or does something with Taiwan. Those are unpredictable risks. My main concern is the problems facing the Chinese growth model. The demographic challenges are real; China’s population is shrinking for the first time in recent history. When that happens, no economy can grow at a significant rate. It will be difficult for China to grow close to 5%.
What is the fate of globalization in this context?
Expect more bilateral and regional agreements [trade] agreements. Look at India – the United Arab Emirates is one of its biggest trading partners and its relationship with Saudi Arabia is growing.
Even with digitization, we are going to see a slowdown in globalization, because now there is much more national sentiment. [and countries] they want the data to stay at home. All facets of globalization face a threat.
We will look back at the pandemic and the invasion of Ukraine as the mark of a very big change in the global economy. nobody is going to close the shop [in China] and come home; too much is invested. But every marginal step will be to have supply chains in more diversified areas that are more secure. It will show up in margins and earnings, not in one or two quarters, but in 10 or 20 quarters.
What does that mean for investors?
Global profit margins are under pressure. The silver lining: Inequality is perhaps beginning to [improve]. The power moves more in favor of labor in the next five to 10 years because companies now have to build closer to home and think more about safe labor versus cheaper labor.
Who are the winners and losers?
Some of the global luxury stocks may be close to a peak as this era of rising wealth based on asset price inflation fades. Instead, more FMCG companies that rely more on the lower end than the middle end of the segment could start to do much better because the bargaining and wage power of [this group] Goes up.
Chinese stocks, especially Internet companies like Alibaba and
Tencent Holdings [0700.Hong Kong]They have been hammered. Do you still want to own Chinese stocks?
I don’t think China is uninvestable, but I want to keep the allocation low, given all the economic risks. Tech companies, they don’t excite me. Those business models are permanently damaged. Among the rubble, we can find some quality stock in China, maybe like
Haidilao International [6862.HongKong]. But the future of this decade belongs to the smaller powers. Portfolio allocations to the US and China are too high.
Staying focused on the US has served investors well over the past decade. What is the case of diversification?
Every decade, there is a new investment theme that captures the world: in the 1980s, it was Japan, which accounted for 50% of the global market capitalization in 1989. In the 1990s, it was American technology. A decade ago, people couldn’t get enough of emerging markets and flocked to the BRICs (Brazil, Russia, India, and China) because they thought they were the future of the world. He had said that the US was going to be the comeback nation. The US stock market tripled and emerging markets did nothing. Now I feel the opposite.
The United States represents 62% of the world market capitalization and the economy represents only 26% of the world economy. The market capitalization of emerging markets is 11%, while their economic size is around 35%. People are relatively massively underallocated.
Emerging markets are not immune to economic challenges. Where are the best opportunities?
Growth expectations everywhere need to be lowered because all economies face the same challenges: deglobalization, demographics, and an environment of higher rates at a time when global debt is high. I can still find relative winners. India, for example, can do well, but its new benchmark for success is more than 5% growth instead of aiming for 7% or 8%.
The best single variable for the performance of emerging markets has been commodity prices. The 1970s were the best years for emerging markets, even before the MSCI index was built. If you have a basic bullish view on commodities, that should generally feed well-performing emerging markets.
I like Indonesia and companies like [conglomerate]
Astra International [ASII.Indonesia] Y
Central Asian Bank [BBCA.Indonesia], a high-quality bank with strong digital initiatives. I also like Brazil, with companies like
Petrobras [PBR] Y
Valley [VALE]and much of Latin America, which is looking better with rising commodity prices.
What’s good beyond the basics?
Diversification away from Chinese manufacturing benefits Vietnam, Bangladesh and potentially Indonesia. While digitization has been hyped in the developed world, it is still in its early stages in emerging markets.
India has a wide margin to benefit. Given much better technology and digital infrastructure, government aid is reaching the poor in ways it never would have before. A beneficiary of digital transformation:
Bharti Airtel [532454.India]. These are the micro changes that are happening in India, Indonesia and elsewhere. I can find 50 quality companies in emerging markets outside of China where I can play these issues on companies with a market capitalization of more than a billion dollars.
How are the valuations?
Quality companies in emerging markets trade at a massive discount to those in developed markets, with opportunities in consumer and technology, outside of large-cap technology. Of the 200 economies in the world, more than 150 are called emerging markets. There are many story lines.
What do investors need to know about the US dollar?
The average lifespan of a reserve currency is usually around 100 years. The US dollar has been a reserve currency for about 100 years; before that, it was the pound sterling. Look at the dollar’s net international investment position, or the amount of debt the US owes to foreigners: US net liabilities to foreigners are now around $16 trillion, an equivalent sum to about 70% of US gross domestic product. Historically, above 50% has signaled trouble for the country’s currency. The US dollar looks stretched.
The sanctions against Russia, from an economic point of view, have sown the seeds of doubt about being on the US dollar standard. The renminbi could have been a natural successor, but China’s financial system is too fragile and its capital accounts are not convertible. There is no alternative today, but things are starting to happen.
Thank you Ruchir.
write to Reshma Kapadia at email@example.com