In 1953, journalist Walter Winchell popularized the term “frienemies” when he used it to describe the fraying relationship between the United States and the Soviet Union. Today, we’re seeing a similar dynamic in our relationship with China. This makes it an important topic for investors.

Not long ago, the relationship between the U.S. and China was strong and mutually beneficial. Over the past 25 years, trade between the two countries has multiplied. At the same time, though, tensions have been growing. American companies operating in China have been complaining for years about intellectual property theft. According to a 2017 report by the non-partisan National Bureau of Asian Research, the cost to the U.S. economy of “counterfeit goods, pirated software, and theft of trade secrets” is at least $200 billion per year and potentially much more.

As a result, over the past several years, both the first and second Trump administrations as well as the Biden administration have imposed tariffs and other restrictions on China. That, in turn, has led to various forms of retaliation by Beijing, including a restriction on “rare earth” exports to the U.S. These minerals are critical inputs for the manufacture of semiconductors, batteries and other electronics.

While less overt, China has been taking other steps to undermine the United States. According to the U.S. government’s Cybersecurity and Infrastructure Security Agency (CISA), China’s government regularly perpetrates cyber attacks against the United States. Targets include both our government and private companies.

China’s relationship with the U.S. is just one reason for concern. Of equal concern: Beijing’s domestic policies, which have negatively impacted investment markets. Of most concern is president Xi Jinping’s posture toward some of China’s largest publicly-traded companies.

Consider Xi’s punishment of Ant Group, a financial technology company founded by entrepreneur Jack Ma. By way of background, Ma was also the founder of Alibaba and is probably China’s most well-known business leader. But in November 2020, Xi’s government halted Ant’s planned initial public offering (IPO) days before it was scheduled to launch.

There was no official word, but observers believe the government’s action was in response to comments Ma had made in the months prior to the planned IPO. He’d criticized China’s banking system, characterizing it as a “pawn shop.” He also criticized government regulators. In the words of one China analyst, “he apparently crossed the invisible red line for what can be said and done in Xi Jinping’s China.”

Soon after, Ma was forced to give up voting control of Ant Group, and the company was fined nearly $1 billion. The government also punished Ma’s Alibaba with a $2.5 billion fine. Both actions were seen as arbitrary. Perhaps more disturbing was that Ma then disappeared from view for several months, raising questions about his wellbeing. He did later reappear, but it was an odd turn of events for someone who had at one point been China’s wealthiest person.

This wasn’t an isolated incident. Over the past five years, Beijing has targeted other powerful technology companies. Many have been fined or sanctioned and, as a result, seen their stocks drop. It levied other seemingly arbitrary fines against Alibaba and Tencent, two of the largest companies not only in China but in the entire emerging markets index. These actions were under the umbrella of a renewed “common prosperity” initiative. Ironically, the result was to erase $1 trillion of wealth from China’s stock market.

In 2024, the planned IPO of online retailer Shein was put on hold when regulators announced a “security review.” This was reminiscent of the action Beijing took against Didi Global in 2021. Didi, which operates a ride-hailing app similar to Uber, had just completed its IPO when the government opened an investigation. The charges were vague, but in the end, it was forced to delist from the stock market, punishing both the company and its shareholders.

Despite the impact on investment markets, Xi’s government shows no sign of slowing its efforts to weaken powerful companies.

James Robinson is an economist who won the Nobel Prize in 2024 for work studying why some countries’ economies do better than others. In a presentation back in 2015, Robinson predicted precisely the problems we’re seeing in China today: “The impulse of the Communist party to suffocate anything that looks vaguely threatening to it politically is fundamentally inconsistent with…innovation.” That was eleven years ago. Recent experience confirms that Robinson was right—that China’s autocratic approach has indeed started to backfire, producing just the sorts of results he predicted.

Another problem in China is one that’s universal to all communist regimes: They believe the government is best suited to direct economic activity. This has manifested in a number of ways. Most notably, authorities have put too heavy of an emphasis on construction. That’s resulted in a surplus of housing units at a time when, due to the country’s one-child policy, the population has been falling. According to one study, there might now be as many as 90 million vacant homes that will never be sold. That, in turn, has resulted in significant bankruptcies among property developers. None of this has been good for investors.

For all these reasons, in recent years I’ve recommended that investors steer clear of investing in China. But since traditional emerging markets indexes typically include a sizable allocation to China, I’ve recommended an alternative: a fund called the Freedom 100 Emerging Markets ETF (ticker: FRDM). Unlike traditional market-weighted index funds, FRDM employs a “freedom-weighted” methodology. China—along with Russia before it went to zero—have never been included in FRDM’s index. And though it’s more expensive than a standard index fund, its higher costs have been more than offset by avoiding exposure to China. Since FRDM’s inception in 2019, it has delivered more than 15% per year. The MSCI Emerging Markets Index, which includes China as its largest weighting, has delivered annual returns of only 9% over that same period.

In the years after Walter Winchell first used the term “frienemies,” the U.S. saw its relationship with the Soviet Union deteriorate further. Whether or not that’s the way things go with China, it makes sense, in my view, to sidestep this risk. Fortunately, investors now have another option: Vanguard recently introduced an ETF that includes all of the major emerging markets countries but excludes China. The ticker is VEXC. It launched less than six months ago, but it’s a promising option to consider.​