Investors Eyeing China to Diversify Risk
Investors are watching U.S. equities with a mixture of enthusiasm and trepidation: The S&P 500 is up 15% over the past year, U.S. Treasury bonds remain relatively stable, and the Federal Reserve's monetary policy is expected to start trending downwards.
But looming over these strong fundamentals are some questions: Is the meteoric rise of the “Magnificent Seven” tech stocks overvalued due to yet-to-be-realized promises of artificial intelligence? Could Trump’s unorthodox foreign policies materially damage the domestic economy? And where might the true winners of the AI race emerge?
Willem Sels, global chief investment officer at HSBC Global Private Banking, says that investors are increasingly answering these questions by diversifying into one key region: China.
In an exclusive interview, Sels said that the U.S. continues to prove its economic resilience and earnings delivery, but geopolitical uncertainty is driving investors to seek balance through other regions.
The Shift Towards Global Diversification
Sels explained that traditionally, the question of politics impacting investment portfolios has been centered on emerging markets, but that has trickled into developed markets in recent years. As a result, diversification has become a more prominent focus – especially for business owners looking to spread risk between the economy they operate in and the assets they use to protect their wealth.
“When a client walks in… the first discussion is, ‘Please build a global portfolio. If you already have your business here, maybe hold as little domestic assets as possible, because that's diversification,’” Sels said. “Obviously, the debate over the last couple of months has been about, will there be a diversification from the U.S. outwards? There are many factors in that.”
Part of the issue is how dominant the large U.S. tech companies have become in the stock market, with the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) contributing most of the growth. Therefore, if these stocks were to run into trouble, it could have a significant impact on portfolios.
“Obviously, you might need to do something around that… to diversify,” Sels said. “We emphasize things like that, making sure that you not only have growth stocks, but you also have some value stocks, do some industry diversification, some geographical diversification, and so on.”
The Impact of Changing Policies on Investment
Sels continued, “The other thing that obviously sparked that diversification discussion is the rapid policy changes in the U.S., and the growth in the debt pile, which led people to raise a question, ‘Is there a de-dollarization story? And what does that mean for my portfolio and other people's portfolios?’ What we see in the data is that there were some outflows of money from bond and equity markets for about two months, but that didn't last– largely because policies have become a bit clearer.”
Safe Haven Funds Flowing Into China
“People are doing a little bit of diversification to other regions, a little bit of diversification to other industries, to reduce the concentration in the U.S. market, but they're not fleeing it,” Sels continued. “People were enthusiastic 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 hard for Asian investors to get excited about Europe.”
Sels noted that part of the problem is that these investors don’t see as many emerging companies that could materially change the European economy, and there is an issue of brand recognition aside from companies like LVMH and BMW.
“This is the first time that we see money flowing out of Europe into China again,” Sels added. “That is very much because people want to participate in the AI trend, and secondly is this ‘anti-lying flat’ concept, accompanied by supply-side reforms, which will address the problem of oversupply, and in turn solve the problem of earnings growth. Now the situation is changing. So we see money coming back, and obviously it is also encouraged by the question ‘How do I diversify my massive U.S. asset backbone?’”
Valuations Remain Low
As discussions about diversifying from the U.S. outwards remain active, China appears to be emerging as the region to balance that risk, Sels says. He added that Chinese stocks in the AI sector are still cheap.
HSBC noted in a report published last week that within the AI ecosystem, infrastructure stocks have outperformed “enablers” and “adopters” since July — 22.2% versus 11.3% and 13.5%, respectively.
Chipmaker Cambricon saw its stock price surge 10% on Wednesday, topping the A-share price list.
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 U.S. stocks at a “30% to 40% discount.”
He said, “We're basically saying, ‘Listen, don't just look at chip makers, but also look at the companies that build infrastructure around it. Those companies that build energy, power supply around it, robotics and automation, that is real, significant innovation.’ So by diversifying across the whole AI ecosystem, I think you solve the question of valuation a little bit.”
The Chinese stock market is currently surging, with the Shanghai Composite Index up 33.4% in the past year, compared to 14.9% for the S&P 500.
Despite significant growth in China, HSBC research indicates that U.S. AI-related capital expenditure (driven by the “Big Four” in Amazon, Alphabet, Microsoft and Meta, as well as Stargate and other private companies) exceeds that of China by a factor of 8 to 10 times (driven by the “Big Four” in Alibaba, ByteDance, Tencent and Baidu, as well as telecom service companies).
In addition, HSBC research found, “U.S. companies are realizing higher returns on AI capital expenditure, and according to Statista, in 2024, U.S. cloud platform revenue is significantly higher than that of its Chinese peers – with the U.S. approaching $400 billion, compared to China’s $60 billion.”
So Sels says that while clients may be balancing an over-reliance on U.S. companies, the upside fundamentals of the U.S. economy remain strong enough to rule out the possibility of an economic recession. Indeed, while recent volatility in tech stocks has sparked questions about an AI bubble, the HSBC executive remains bullish: “We certainly think that the take-off of the AI concept is fundamentally structural.”
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