Global Investors Eye China for Diversification Amidst US Tech and Policy Concerns

Concerns Fueling Global Diversification

Investors are watching the US stock market with a mixture of enthusiasm and caution, driven by the S&P 500's 15% rise over the past year, relatively stable US Treasury bonds, and expectations of easing monetary policy from the Federal Reserve. However, some looming challenges cast a shadow over this positivity.

One such challenge is the significant growth of the 'Magnificent Seven' tech companies, raising questions about whether these companies are overvalued due to yet-to-be-realized promises in the field of Artificial Intelligence. Additionally, the potential return of Trump to power raises concerns about the impact of his unconventional foreign policies on the domestic economy. The question also remains open about the real winners in the AI race.

Many investors are answering these questions by diversifying into one key region: China, according to Willem Sels, global chief investment officer at HSBC Private Banking.

In an exclusive interview, Sels noted that while the US continues to prove its economic resilience and earnings delivery capabilities, geopolitical uncertainty is driving investors to seek out other regions to balance risk.

Sels explains that concerns about the impact of politics on investment portfolios were traditionally confined to emerging markets, but in recent years have spilled over into developed markets. As a result, diversification has become an increasing focus, especially for business owners looking to spread risk between the economy in which they operate and the assets used to protect their wealth.

"When a client comes in… the first discussion is, 'Please build a global portfolio. If you already have your business here, perhaps hold as little domestic assets as possible, because that’s diversification,'" Sels says. "Clearly, the debate for the last couple of months has been about, will there be diversification outward from the US? There are many factors that go into that."

Dominance of Mega-Cap Tech Companies

Part of the problem lies in just how dominant US mega-cap tech companies have become in the stock market, with the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) contributing the bulk of the growth. Therefore, if these stocks were to run into trouble, it could have a significant impact on investment portfolios.

“Clearly, you might need to do something around that… to diversify,” Sels says. “We emphasize things like that, making sure that you not only have growth stocks, but also some value stocks, some industry diversification, some geographical diversification, etc.”

“Clearly, the other thing that sparked that diversification discussion is the rapid policy changes in the US, and the growth in debt accumulation, leading to a question being asked, ‘Is there a de-dollarization story? What does that mean for my portfolio, and for other people’s portfolios?’ What we saw in the data is that for about two months, there were some outflows from bond and equity markets, but that didn’t last -- largely because policy has become a bit clearer.”

Safe Haven Funds Flowing into China

“People are diversifying a little bit into other regions, a little bit into other industries, to reduce the concentration in the US market, but they’re not running away from it,” Sels says. “People had enthusiasm about European equities, but that was very short-lived. My experience going to Asia for the last 15 to 20 years is that it’s difficult for Asian investors to get excited about Europe.”

Sels adds that part of the problem is that these investors don’t see as many emerging companies that can fundamentally change the European economy, and that there is a brand awareness issue aside from companies like LVMH and BMW.

“This is the first time that we’re seeing again money flowing from Europe into China,” Sels adds. “That’s largely because people want to participate in the AI trend, and second is this concept of ‘anti-involution,’ accompanied by supply-side reforms that will solve the surplus problem, and, in turn, solve the earnings growth problem. Now the situation is changing. So we’re seeing money flow back in, and it’s obviously encouraged also by the question of, ‘How do I diversify my big US asset backbone?’”

Valuations Still Low

With the discussion about diversification outward from the US remaining active, China seems to have emerged as a region to balance that risk, Sels says. And the Chinese stock market's current hot sectors—AI prices are still cheap.

In a report released by HSBC last week, it was stated that within the AI ecosystem, infrastructure stocks have outperformed the “enablers” and “adopters” since July—22.2% versus 11.3% and 13.5%, respectively.

Chipmaker Cambricon's stock price soared 10% on Wednesday, once topping the list of A-share stock prices.

While Cambricon represents an example on the higher end of the price scale, Sels emphasizes that investors can still find other Chinese stocks comparable to US stocks at a “30% to 40% discount.”

He says, “We’re basically saying, ‘Listen, don’t just look at chipmakers, but also look at the companies that build infrastructure around it. Those that build energy, electricity supply around it, robotics and automation, that’s the real, significant innovation.’ So by diversifying within the whole AI ecosystem, I think you address the valuation issue a little bit.”

The Chinese stock market is currently soaring, with the Shanghai Composite Index up 33.4% in the past year, compared to the S&P 500's 14.9% rise.

Despite China's significant growth, HSBC research notes that the United States' AI-related capital expenditure (driven by the “Big Four” of Amazon, Alphabet, Microsoft and Meta, as well as Stargate and other private companies) is 8 to 10 times larger than that of China's “Big Four” (Alibaba, ByteDance, Tencent and Baidu, plus telecommunications service companies).

Furthermore, HSBC research found: “US companies have achieved higher returns on AI capital expenditure, and according to Statista, in 2024, US cloud platform revenues were significantly higher than their Chinese counterparts—with the US approaching $400 billion, while China is at $60 billion.”

So Sels says that although clients may be balancing an over-reliance on US companies, the upside fundamentals of the US economy remain strong enough to rule out the possibility of a recession. Indeed, despite recent volatility in tech stocks sparking questions about an AI bubble, the HSBC executive remains bullish: “We certainly think that the take-off of the AI concept is fundamentally structural.”