Emerging markets: Tapping into the tech take-off

Despite concerns around the potential impact of tariffs, investor interest has swung towards emerging market equities in recent weeks following the release of DeepSeek’s new AI model. While investors remained cautious when China’s equity market first began to take off late last year following government stimulus announcements, sentiment has recently reversed. The iShares China Large Cap ETF (IZZ) saw more than $20 million inflows in February 2025, taking the fund into our top 5 ETFs on an inflow basis for the month after a year of outflows in 2024.¹

Tech turnaround: IZZ monthly average net flows, 2024 vs YTD

Source: BlackRock data as of 3 March 2024

As market nerves around US equities have intensified in the early months of 2025, Chinese and Asian equities exposures have also overtaken US and broader global shares from a performance perspective. In the six months to January 2025, the FTSE China 50 Index returned more than 29%, versus just over 15% for the S&P 500 and 11% for the S&P Global 100 Index.² Similarly, the S&P Global Asia 50 Index, tracked by our iShares Asia 50 ETF (IAA), outperformed broader global equities over the same 6-month period, returning around 14%.³

Other emerging markets have not fared as well, underlining the point that China is decoupling from its fellow EM economies in terms of macro drivers of growth. While India has faced a slowdown in GDP, with growth revised down to its lowest level since the pandemic⁴, South Korean equity markets have also been challenged by political instability following the impeachment of President Yoon Suk Yeol. In the US, iShares’ Indian equities exposure saw more than US$1 billion net outflows in the first six weeks of 2025⁵, indicating investors may be tactically shifting their emerging market exposure from India to China.

Much of the current positive performance and investor sentiment around China is being driven by AI optimism and excitement. The launch of DeepSeek’s AI model showing comparable performance to US rivals, but with lower costs and using less advanced computer chips, has disrupted and challenged the tech sector – as seen in the chart below.

China’s AI model has leading capabilities and competitive pricing

Source: Artificial Analysis, data compiled by Goldman Sachs Global Investment Research as of February 2025

Such advancements will likely enable faster and cheaper adoption of AI, particularly across other areas of competitive advantage in the Chinese tech sector. For instance, China holds a 63% market share in the humanoid robot supply chain⁶, and its autonomous driving market is expected to reach US$639 billion by 2030.⁷ However with the success of China’s tech innovation now taking centre stage in equity markets, the sector could become a target for future US trade barriers, following restrictions already imposed by the former Biden administration on US investment into Chinese AI technologies.

From a macro perspective, recent reports that Chinese authorities are looking at a US$55 billion recapitalisation plan for some of the country’s largest banks⁸ have added further weight to positive tactical views on Chinese equities. The nation has also flagged it will increase its budget deficit from 3% to 4% of GDP in 2025.

Increasing the might of China’s economic stimulus program may also help to offset the impact of additional tariffs recently imposed by the US, as well as boosting domestic economic activity and consumer sentiment, which could potentially broaden the China rally beyond tech.

Since a significant proportion of revenue from Chinese companies comes from within China, we see the domestic equity market as potentially quite insulated from tariffs. Notwithstanding other economic challenges, this is also the case for any reciprocal tariffs placed on India, as seen in the chart below.

Chinese and Indian companies derive most of their revenues from domestic consumers

Source: BlackRock, MSCI, as of 30 September 2024

With the spectre of reciprocal tariffs from the US now also being raised, the potential impact to growth now extends to emerging markets beyond China. Countries with wide current tariff differentials with the US – such as India, South Korea and Argentina⁹ – may be the most at risk of being hit with significant trade barriers.

In the short term, it’s likely tariff announcements will continue causing headlines and volatility in the coming months. But looking strategically, exposure to structural ‘mega forces’ – in India’s case, favourable demographics, and in South Korea’s, an economy that’s set to benefit from the AI revolution – makes emerging markets a favourable region for longer term growth opportunities.

As AI optimism and the potential for further stimulus continues to bolster Chinese equity performance, investors could consider taking a granular approach by carving out China from other emerging markets. Using a combination of emerging markets ex China, and Chinese equity exposures allows for a tactical overweight to China, while still keeping some broader emerging markets exposure to take advantage of longer-term growth.

Asian equity exposures offer another way to tap into current regional tech outperformance. Top holdings in the S&P Global Asia 50 Index include Chinese tech names Alibaba, Tencent and Meituan, as well as TSMC which recently announced a US$100 billion deal to make semiconductor chips in the US.¹⁰ Investors can tap into the index through IAA, currently the lowest cost Asian equities ETF on the ASX.¹¹

Another alternative is to take broad emerging markets exposure, for simple diversification against any further volatility in the US.¹² Comparing monthly returns of the MSCI Emerging Markets Index and the S&P 500 over the past 10 years, we’ve seen the two markets move quite separately to each other, with a low performance correlation of just 0.37 – indicating this type of allocation may help insulate portfolios in the months ahead.¹³

With risks rising and sentiment beginning to shift somewhat around the US-centric market narrative, China and other emerging markets remain worthy of investor consideration. Offering diversification benefits, exposure to long-term growth stories and a likely boost from China’s economic stimulus and innovation progress, the region may be set to continue driving positive sentiment in markets.