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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is the chief global strategist at Principal Asset Management
Each wobble in US technology stocks revives the same question for global investors: how do you diversify away from the market’s most powerful engine? Years of outperformance have left global portfolios heavily tilted towards a small group of companies, while benchmarks have become increasingly dependent on the same trade. Diversification is easy to recommend, but it is much harder to implement.
The menu of other compelling options is narrowing. Last year, Europe was the diversifier of choice, helped by cheaper valuations, a brief outbreak of fiscal seriousness and the somewhat mixed blessing of not having much of a tech sector to speak of. But Europe is a net energy importer. Although the peace deal between Iran and the US has avoided the worst-case scenario, the situation remains febrile.
Equally, to function as an effective hedge, investors would need to see improved fundamentals in Europe: increased growth, higher earnings and a signal that the European Central Bank is not going to overstep the mark in tightening monetary policy. But the continent lacks the firepower for growth enjoyed by the US: AI-driven earnings growth and light-touch regulation. The US fiscal impulse is also larger.
Emerging Asia also offers very little shelter. The region is increasingly tied to the same AI cycle investors are trying to hedge. Taiwan and South Korea sit at the centre of the global semiconductor supply chain and now account for about half of the MSCI Emerging Markets index. If US AI capex disappoints, Nasdaq contagion would spread rapidly across emerging Asia.
That leaves China. For many investors, this remains an uncomfortable answer. China carries well-known risks: policy opacity, property sector weakness, demographic challenges, geopolitical tensions. None should be dismissed. But diversification is not about finding a market without risk. It is about finding a market whose risks are different. On that basis, China is becoming harder to ignore.
The first reason is relative energy autonomy. In stark contrast to Europe’s wait-and-watch approach, Beijing’s investment in energy security appears based on the assumption that the world will remain disorderly. China is not immune to global energy shocks, but it has spent years building resilience to them. Alongside strategic oil stockpiling, the country is the world’s largest electricity producer from renewable resources and is installing more wind turbines and solar panels than the rest of the world combined. According to the International Energy Agency, China’s clean energy investment exceeded $625bn in 2024, hitting its 2030 wind and solar capacity target six years early.
Second, in contrast to US tech, which depends on inputs from across the world, China’s supply chain is now highly internalised. This is in part thanks to US export controls, which were introduced to slow China’s access to advanced semiconductors but had the unintended consequence of accelerating Beijing’s self-sufficiency. The result is a more domestically focused technology ecosystem, with domestic AI models, local fabrication capacity and a tight grip on rare earths.
The third reason is correlation — or rather, the lack thereof. China’s push for autonomy has made its equity market behave differently from global peers. The 12-month average of the two-year rolling correlation between MSCI China and the S&P 500 is now just 14 per cent, compared with 70 per cent during 2018-19. It has similarly decoupled from other major developed equity markets, showing only about a 3 per cent monthly correlation with MSCI Japan and 29 per cent with MSCI Europe today. Just before Covid-19, those percentages hovered around the 70 per cent mark, as with the US.
None of this means that China is a simple substitute for American stocks. The US has already imposed some restrictions on investment into Chinese tech and there are indications the EU may do something similar. But the old diversification map needs updating. Investors worried about US technology concentration won’t find a hedge in another market tied to the same capex cycle. It will have to be a market with a different macro engine, a different policy cycle, and a different set of geopolitical exposures. China increasingly stands out as a market that ticks those boxes.
Markets have a penchant for irony. The hedge against American exceptionalism may be the very market Washington has tried hardest to isolate.
