Emerging market stocks have just been downgraded. Blame in China.

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Some US-listed Chinese stocks have fallen. Above is a scene from the New York Stock Exchange.

NYSE

Emerging market stocks have been downgraded as Chinese regulatory crackdowns become too important to ignore, and Chinese stocks make up a large part of the indices that track companies in developing countries.

Hong Kong

The Hang Seng Index fell nearly 20% from its high in 2021 on February 17 to the late Tuesday afternoon, as investors got used to Beijing’s moves that would force some education companies to become nonprofits, require grocery delivery services to pay couriers at least the minimum wage, and restrict capital raising in some companies. But since then it has started to rebound, up nearly 5% from the lows.

That’s part of the problem. On Wednesday night, Truist downgraded emerging market stocks, calling them “less attractive” and citing this week’s comeback.

Even if share prices in China are off their lows, the earnings picture is likely to deteriorate. “Our concerns only grew as the raid spread to other areas, such as education companies, and it could be targeting other industries,” wrote Keith Lerner, chief market strategist at Truist. “This will likely lead to further weakness in earnings.”

It’s hard to predict how much earnings will drop, but the drop could easily mean investors are unwilling to pay that much for Chinese stocks, he said. Some US-listed Chinese stocks have lost ground.

The reason that poorly performing Chinese stocks likely means the same thing for emerging markets in general is that Chinese stocks make up a large part of the asset class. Lerner noted that China is heavily weighted in the emerging market indices.

Chinese stocks make up 38% of the MSCI Emerging Markets Index. From when the Hang Seng peaked in 2021 to its most recent low, the

iShares MSCI Emerging Markets

Exchange Traded Funds (EEM) fell 13%.

Investors are buying the dip, but it makes sense to continue to watch the profits of Chinese companies that are vulnerable to regulatory changes.

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