With negative sentiment around deflation and geopolitics creating a $43tn market cap gap relative to the US, Beijing is hoping policy changes could still bear fruit.
China is battling domestic deflation caused by its self-inflicted real estate meltdown, while preparing itself for harsher confrontation with the US under Trump 2.0.
Sentiment has been poor. Rather than praising Chinese growth for boosting the fortunes of companies worldwide, the ongoing malaise in Beijing and Shanghai has now become an excuse for underperformance.
On earnings calls, global multinationals cite China’s slowdown as the most common cause for trading weakness. This is particularly evident from industrial, consumer and luxury companies, and it has impacted European companies the most.
China is also partially blamed for US market ‘exceptionalism’. Why? Because China’s equity market capitalisation has lost more than $6tn since its peak in 2021. The market capitalisation gap with the US has widened to $43tn from $29tn in just three years.
Despite all of this, and the lack of sustained market progress since last September’s pro-growth policy shift, China still has plenty to offer in 2025, whatever the doomsayers claim.
MSCI China currently trades on a 10x forward price earnings ratio, well below its historic average. But earnings are expected to grow in the low double digits percentage range. Both state- and privately-owned enterprises are increasing shareholder returns via share buybacks, dividend improvements and better use of cash flow.
Given that the world’s formerly China-centric global supply chain has been rewired since Donald Trump’s first period in office, China is better prepared this time. Tariff hikes will have limited impact on China, especially given their likely side-effects on US inflation, and therefore US consumers. Most economists expect close to zero export contribution to China GDP growth in 2025. So the expectation backdrop is low.
Big cats and mice catchers
Moreover, in addition to a tech stand-off with the US, we are also experiencing a renaissance in Chinese entrepreneurship, emanating from a lively private sector.
The breakthrough made by DeepSeek, in its open-source V3 and R1 large language AI model, attracted widespread attention towards Chinese tech capabilities. As the Year of the Snake starts to gather momentum, companies like Unitree, Deep Robotics, ManyCore, BrainCo, Game Science — the “Hangzhou Six Tigers” — are showing the innovation and engineering heft of Chinese private sector players. China’s private sector is not only investable but also vibrant and value creative.
China is also reassessing the balance between state-owned enterprises and private enterprises. It is time for the private sector to shine again. It contributes 50 per cent of GDP, 60 per cent of fiscal income, 70 per cent of intellectual property patents, 80 per cent of job creation and makes up 90 per cent of Chinese companies.
The narrative from China’s leadership is pivoting from ‘common prosperity’ to ‘black cat, white cat’: it does not matter whether a cat is black or white, as long as it catches mice.
We believe the Chinese government policy pivot last September was real, despite that stimulus alone not having been sufficient to transform consumer sentiment and reverse the economy’s deflationary trend.
With stabilisation of the real estate market and decisive action by government to make economic growth the priority, China will find its recovery path and avoid the long-term stagnation and deflation we know as Japanisation.
Despite previous clampdowns, investors are better positioned today to favour Chinese technology companies, especially in the private sector. Deflation susceptible companies exposed to consumer sectors with weak pricing power, such as sportswear and catering, should be avoided.
When it comes to searching for a revival in animal spirits, beyond the US Magnificent Seven, the big cats of Hangzhou could well come to the fore for portfolio investors.
Xiadong Bao, manager, Edmond de Rothschild China fund
