What’s Your China Exposure Amid the Trade Skirmish?

One of the interesting things about the current trade skirmish (I’m not willing to call it a war yet), is that we are fighting on multiple fronts.

Even though we have tariffs on aluminum and steel from Canada, Mexico, and the European Union, we all know that the primary combatant in this altercation is China.

Even more interesting, perhaps, is that we have more exposure to China than ever before, without any new securities or shifts to our asset allocation policy.

Diligent readers may remember that three years ago, I wrote that China was the second largest stock market in the world, but you’d never know it because the shares don’t trade freely outside of China – well less than 10 percent of Chinese stocks are held by investors outside of China.

In that article, which you can read here, I wrote that Vanguard received approval from the Chinese government to include mainland Chinese stocks in their indexes.  In the article, I noted that the fund had a 29 percent exposure to Chinese stocks at that time, which would increase to 36 percent in the coming years.

Fast forward to 2018, and guess what the exposure is to China in the Vanguard ETF that we use?  You got it: 36 percent, as promised by our friends in Malvern, PA.

How should we feel about the increased China exposure?

Well, this year, it’s not so great since the markets think that the US is winning the trade skirmish at this point.  As of Friday, the S&P 500 was up 5.8 percent while mainland Chinese stocks (as measured by the MSCI China A IMI index) are down -20.8 percent.

I’d rather have the 29 percent instead of the 36 percent this year, but the reality is that we don’t have that much exposure to emerging markets in the first place – for a 60/40 stock/bond portfolio, the exposure to China went from 0.9 percent to 1.1 percent.  That’s hardly enough to lose any sleep over.

Even though mainland Chinese stocks have dropped by -20.8 percent, our Vanguard emerging markets ETF is ‘only’ down by -7.3 percent.

Of course, I would prefer gains like the S&P 500, but we have clearly benefited by having broad exposure to the asset class, as opposed to trying to pick winners and losers from within the asset class.

Over the long run, I believe that exposure to China is a good thing.  Not only do I like the diversification benefits, but I believe the story that as the worlds second largest economy grows, their stock market will grow with it.

To be sure, China has problems, but I suspect that that Chinese stocks will fare well in the coming decades (with bumps along the way, of course).

At some point, the current trade situation will pass, hopefully without ever becoming a true war.  In the meantime, we’ve looked at our exposure to China and are not concerned at this point.