Despite a shift in government policy towards a more pro-growth stance in September 2024, few would’ve predicted China to be the leading global equity market in 2025, returning almost 25% to investors year-to-date.
The turnaround is stark when compared with 2022 and 2023, when the MSCI China fell 14% and 18% respectively. But investor uncertainty remains – on the one hand the likes of Goldman Sachs believe Chinese stocks could rise by about 30% through the end of 2027, aided by policy tailwinds and reallocation of global and household assets – while others are quick to point to slowing growth, a property crisis and weakening corporate earnings.
The MSCI China is now on a forward P/E of 13.8x, with the adjustment bringing it towards its historical average. But I’d argue that if you scratch beneath the surface there are still plenty of opportunities to be had for good stock pickers.
For example, I recently caught up with Fidelity China Special Situations manager Dale Nicholls, who was keen to point out that, with the exception of technology, most other sectors have had consistent earnings downgrades in recent times. However, he says there are signs of that turning.
Alongside the political pivot and geopolitics, AI has been one of the leading drivers of the equity rally in China. At the start of the year, DeepSeek shook financial markets when it announced the development of an AI model with the same functionality as ChatGPT, but at a significantly cheaper cost.
Nicholls is quick to highlight that, despite the strong returns from Chinese tech firms, investment in AI in China is about 18 months behind the US, indicating the main driver to the US could easily feed through to China in the not too distant future. Let’s put a bit of meat on the bones of demand for AI in China – it accounts for 50% of demand for industrial robots; 60% of new cars in China have advanced driver-assisted solutions; and China ranks number one globally for AI patents with a 50% market share.
The turn in earnings is very important. The big drag has been on consumption – so we have seen weak consumption and consumer confidence and this is tied to two things – perceptions around income and perceptions around assets.
Nicholls cites a quartet of areas he has targeted in markets. The first, and biggest of these, is industrials, where he says exposure is broad, pointing to the wider market still understating the competitive nature of a number of Chinese industrial companies. Others include the consumer, healthcare and, perhaps most interestingly of all, the property sector.
Matthews Pacific Tiger fund co-manager Andrew Mattock agrees that investors should focus more on returns driven by the broader economy and earnings growth – with figures from the last quarter looking encouraging across most sectors, with the exception of the consumer and real estate.
He says: “Financials, particularly life insurance companies, performed well. We are seeing a structural shift as savers move from putting savings into property or on deposit and instead into life insurance investment products. We also saw robust earnings in utilities, materials and industrials, including electrical vehicle (EV) battery suppliers, and healthcare, e-commerce, internet platforms and IT.”
We are still in the bottoming phase for the property sector and while we are unlikely to return to the strong markets seen previously, there now appear to be opportunities at good pricing points. Mattock says the property market remains the single most important factor in supporting China’s economic expansion, adding that real estate has experienced month-on-month price declines since mid-2021 – something which hits consumer and household confidence.
Beyond earnings, the other major factor holding Chinese markets back from broadening out is tariffs and the lack of certainty around them. There are a number of considerations here, not least that not only is the Chinese government prepared for tariffs – with only 3% of the MSCI China’s revenues linked to US exposure – but a recent meeting between Donald Trump and Xi Jinping does offer confidence that a full deal can be made – which would be a positive for companies, consumers and markets.
If an agreement is upheld, China would face tariffs of around 47%, but we must remember China survived paying 25% in Trump’s first tenure, while on this occasion others are paying while China’s own economy is getting stronger.
The final point I want to touch upon is that the Chinese government is placing a greater focus on the domestic economy – resulting in an increasing preference among Chinese consumers and corporates for Chinese brands and local suppliers. Foreign investors only own around 3% of the China A-Share market, meaning domestic investors dominate sentiment and they have remained cautious until recently, with figures from Allianz Global Investors showing there are around $7 trillion of “excess savings”. That’s about half the size of the China A-Share market. If that starts to move, the market will re-rate at pace.
Chinese corporates also have around $2.4trn of cash on their balance sheets. Regulators have also sought to improve shareholder returns, with share buybacks in China A-Shares reaching record levels in 2024. While many companies previously only paid dividends once a year, a number are now introducing an interim dividend. Regular payments are another boon for retail investors – encouraging them to come off the sidelines.
Despite the recovery, valuations in China still look attractive. The 12-month forward price-to-earnings for the MSCI China is at roughly a 40% discount to the S&P 500. Clearly there will be more volatility, but this should also bring greater opportunities at a time when finding value across global markets is challenging.
Those looking for a pure China offering might consider the JPMorgan China Growth & Income trust or a domestic-focused offering like Allianz China A-Shares, which targets sustainable growth businesses at reasonable valuations in a 50-70 stock portfolio. Those who are warier may look to an emerging markets offering like Matthews Pacific Tiger or M&G Global Emerging Markets, which have 36% and 24% in China respectively.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above should not be taken as investment advice.