Roughly a decade ago, when investors were still enamored with emerging markets and down on the U.S., Ruchir Sharma hailed the U.S. as the comeback nation, rightly forecasting the subsequent bull market. Today, Sharma, chairman of Rockefeller International, the international arm of Rockefeller Capital Management, sees the best opportunities outside the U.S. and China, the world’s two largest economies.
After working for 25 years in Morgan Stanley’s investment management business, most recently as chief global strategist, 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, about the challenges that companies and investors face in China, why he is avoiding Chinese technology stocks such as
Alibaba Group Holding
(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, grinding war. It is going to affect things in decimal points versus percentage points.
I am not stressed about China joining Russia and this becoming a third World War. China is much more entrenched in the Western financial system and cares about that much more than [Russia does]. That’s a check and balance on China’s ability to act. China’s economy is also weak—and it cares 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 office in the fall?
We have no idea. But China is deviating from one of its key successes over the past 40 years: They were very clear that no leader could serve out more than two terms. That always brought renewal—a churning of the leadership. [Xi getting a third term] is a big difference. I’m much more concerned about the Chinese economy becoming less robust over time.
The other concern is China’s debt path, and the fallout from its debt-dependent growth over the past decade. Xi realizes [the debt problem], which is why he is trying to crack down on the property sector. [Top economic adviser] Liu He realizes the vulnerability that too much debt brings to the economy and how past Chinese empires have been brought down by debt. But anytime they want to reduce debt, the economy slows and they inject more debt.
Should foreign investors, and companies, still seek a foothold in China?
The emerging market I’m least excited by is China. Everyone needs to think about how to diversify outside of China. The risk isn’t so much that China joins the war with Russia or does something with Taiwan. Those are unpredictable risks. My main concern is the issues 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 is able to grow at any significant pace. It will be difficult for China to grow anywhere close to 5%.
What is the fate of globalization against this backdrop?
Expect more bilateral and regional [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 there is much greater national sentiment now [and countries] want data to remain at home. All facets of globalization are facing 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. No one is going to shut shop [in China] and come home; too much is invested. But every marginal step will be about having supply chains in more-diversified areas that are more secure. It will show up in margins and earnings, not in a quarter or two but maybe in 10 to 20 quarters.
What does that mean for investors?
Global profit margins are under pressure. The silver lining: Inequality maybe starts 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 secure labor versus the cheapest labor.
Who are the winners and losers?
Some of the global luxury stocks may be close to a peak as this era of increasing wealth based on asset-price inflation fades. Instead, more mass-consumer companies that rely more on the lower- to mid-end of the segment could begin to do much better because the bargaining and wage power of [this group] goes up.
Chinese stocks, especially internet companies like Alibaba and
[0700.Hong Kong], have been hammered. Do you still want to own Chinese stocks?
I don’t think China is uninvestible, but I want to keep the allocation low, given all the economic risks. The technology companies, I’m not enthused about. Those business models are permanently damaged. In the rubble, we can find some quality stocks in China, maybe like
[6862.HongKong]. But the future of this decade belongs to smaller powers. The allocations in portfolios to the U.S. and China are too high.
Staying focused on the U.S. has served investors well over the past decade. What is the case for diversifying?
Every decade, there’s a new investment theme that captures the world: In the 1980s, it was Japan, which was 50% of the global market cap in 1989. In the 1990s, it was U.S. tech. A decade ago, people couldn’t get enough of emerging markets and were crowding into the BRICs—Brazil, Russia, India, and China—because they thought it was the future of the world. I had said the U.S. was going to be the comeback nation. The U.S. stock market tripled, and emerging markets did nothing. Now, I feel the opposite.
The U.S. is 62% of the global market cap, and the economy is just 26% of the global economy. Emerging markets’ market cap is 11%, while its economic size is about 35%. People are relatively massively underallocated.
Emerging markets aren’t immune to the economic challenges. Where are the best opportunities?
Growth expectations everywhere have to be reduced because every economy is facing the same challenges: de-globalization, demographics, and a higher-rate environment 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 growth north of 5% rather than aspiring to 7% to 8%.
The single best variable for the performance of emerging markets has been commodity prices. The 1970s were the best years for emerging markets—before the MSCI index was even constructed. If you have a basic bullish view on commodities, that should generally feed into emerging markets doing well.
I like Indonesia and companies like [conglomerate]
Bank Central Asia
[BBCA.Indonesia], a high-quality bank with strong digital initiatives. I also like Brazil, with companies like
[VALE], and much of Latin America, which looks better with rising commodity prices.
What’s to like beyond commodities?
Diversification away from Chinese manufacturing benefits Vietnam, Bangladesh, and potentially Indonesia. While digitization has been overhyped in the developed world, it’s still at early stages in emerging markets.
India has ample scope to benefit. Given much better technology and digital infrastructure, the government’s aid reaches the poor in ways that it never would have before. One beneficiary of digital transformation:
[532454.India]. These are the micro changes happening in India, Indonesia, and elsewhere. I can find 50 quality companies in emerging markets outside of China where I can play these themes in companies with a market cap of more than $1 billion.
What are valuations like?
Quality companies in emerging markets are trading at a massive discount to those in developed markets, with opportunities in consumer and technology, outside of big-cap tech. 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 U.S. dollar?
The average duration of a reserve currency typically is about 100 years. The U.S. dollar has been a reserve currency for about 100 years; before that, it was the British pound. Look at the dollar’s net international investment position, or the amount of debt the U.S. owes to foreigners: U.S. net liabilities to foreigners are now around $16 trillion, a sum equal to around 70% of U.S. gross domestic product. Historically, above 50% has been a sign of trouble for the country’s currency. The U.S. dollar is looking stretched.
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