Strategic Rebalancing in Emerging Market Portfolios Amid China's Equity Volatility and Sino-US Tensions

The China equity market in 2025 has become a focal point of global investor anxiety, driven by escalating Sino-U.S. geopolitical tensions, the specter of steep tariffs, and domestic economic headwinds. An Asia Times analysis notes the A-share market is navigating a perfect storm of deflationary pressures, downward earnings revisions, and the risk of a 25% U.S. tariff on Chinese imports under the Trump administration. The Morgan Stanley A-Share Sentiment Index has plummeted 8 percentage points to 77%, reflecting eroding confidence and reduced trading activity in key segments. This volatility is not isolated to China; it reverberates across emerging markets (EMs), where divergent economic fundamentals and policy trajectories are reshaping investment strategies.

The Dual Threat: Tariffs and Geopolitical Uncertainty

According to a U.S. News report, the U.S.-China trade war has intensified, with tariffs on Chinese goods surging to 125% and China retaliating with 84% tariffs on U.S. imports. While U.S. exports account for only 3% of China's GDP, the symbolic and psychological impact of these tariffs has been profound. Morgan Stanley warns that aggressive U.S. monetary policy and yuan depreciation could elevate equity risk premiums in China, further straining investor sentiment. Meanwhile, the Hang Seng Index's sharp mid-2024 rally-driven by hopes of fiscal stimulus-was reversed after Trump's election and the November National People's Congress delivered weaker-than-expected policy outcomes, according to a Matthews Asia outlook.

Emerging markets are now grappling with a bifurcated landscape. While China faces structural challenges-aging demographics, property sector woes, and supply chain vulnerabilities-other EMs like India have shown resilience. India's growth trajectory, supported by demographic dividends and pro-business reforms, contrasts sharply with markets such as Taiwan and South Korea, which face sector-specific risks from U.S. tariff threats. This divergence underscores the need for strategic rebalancing in EM portfolios.

Strategic Rebalancing: Prioritizing Resilience Over Exposure

For investors, the key lies in recalibrating EM portfolios to mitigate China-specific risks while capitalizing on opportunities in more resilient economies. Morgan Stanley recommends favoring A-shares with strong profitability and return on investment, such as technology and consumer discretionary sectors, while avoiding firms vulnerable to supply chain disruptions. However, this approach must be tempered with a broader EM lens.

1. Underweight China-Exposed Assets: Given the potential for a 60% U.S. tariff on Chinese goods-though its direct economic impact may be limited-investors should reduce exposure to sectors like manufacturing and export-driven industries.
2. Overweight Diversified EMs: Countries like India, Indonesia, and Vietnam, with stronger growth fundamentals and less reliance on U.S.-China trade, offer more balanced risk-return profiles.
3. Hedge Against Currency Volatility: The yuan's depreciation risk necessitates hedging strategies, particularly for EM portfolios with significant China exposure.
4. Monitor Policy Developments: While Trump's tariffs may have peaked, ongoing negotiations and potential trade deals remain critical variables.

Navigating the New Normal

The Sino-U.S. trade war has accelerated a shift toward regionalization and supply chain diversification. As multinational corporations relocate production to reduce tariff risks, EMs with strategic geographic and labor advantages-such as Mexico and Southeast Asia-are gaining traction. However, this realignment also introduces new uncertainties, including fragmented global trade and heightened geopolitical competition.

For now, Chinese investors remain cautiously optimistic. Liam Zhou of Minority Asset Management argues that U.S. tariffs are unsustainable and will eventually lead to a domestic recession, while China's low valuations and reduced U.S. market dependence provide a buffer. Yet, this optimism must be balanced with pragmatism. Charu Chanana of Saxo notes that while trade deal hopes persist, the trade-weighted effective tariff rate remains high, and policy clarity is elusive.

Conclusion

The 2025 China equity market volatility, fueled by Sino-U.S. tensions, demands a recalibration of emerging market investment strategies. By underweighting China-exposed sectors, diversifying into resilient EMs, and hedging currency risks, investors can navigate this turbulent environment. As the global economy grapples with fragmentation and macroeconomic divergence, strategic rebalancing is not just prudent-it is imperative.