View article in Investment Week
This year, China has emerged as a tale of two sides.
On the one hand, economic data remains soft, highlighting ongoing challenges in the broader economy. On the other, equity markets have rallied, placing China among the top-performing countries year-to-date. Yet this momentum appears at odds with fundamentals, as gains seem driven largely by multiple expansion than earnings growth.
July’s economic data, released by the National Bureau of Statistics, missed consensus estimates, highlighting the problems inherent in China’s economy.
Continued weak domestic demand was evident in retail sales growing by just 3.7% YoY, down from 4.8% in June and marking the slowest growth in five months, while the ongoing property sector crisis was evident in property investments falling to -12% YoY from -11.2% in June.
Other indicators also disappointed: unemployment rose, bank loans shrank for the first time since 2005 and fixed asset investment slowed to 1.6% YoY.
Manufacturing exports rose 7.2% YoY, but this was largely due to exporters rushing shipments ahead of anticipated US tariffs. Industrial output grew just 5.7% YoY, down from 6.8% in June – the slowest pace since November.
This slowdown was partly due to adverse weather conditions as both unusually high temperatures and flooding disrupted factory activity and construction.
What is more, China’s producer prices fell by 3.6% YoY, marking the 34th consecutive month of producer deflation, highlighting China’s ‘involution’ problem, whereby fierce competition drives prices down, eroding margins and profitability.
E-commerce giants like Temu and AliExpress exemplify this dynamic.
To stimulate domestic demand, Beijing has introduced several measures. A home appliance trade-in scheme offers subsidies of up to 20%, now extended through year-end.
In July, annual subsidies of 3,600 yuan ($500) per child under three years were introduced to boost consumption and address demographic challenges. A one-year consumer loan subsidy programme begins in September, offering 1% interest subsidy on loans up to 50,000 yuan.
However, such subsidies offer only short-term relief and, once withdrawn, demand may falter, as they likely will not address deeper issues: low household confidence, especially with 70% of wealth tied to a declining property market and overcapacity in the private sector.
Monetary policy has also been accommodative. The People’s Bank of China cut the reserve requirement ratio by 0.5 percentage points in May and lowered key interest rates, injecting RMB 1trn in long-term liquidity. Yet the issue is not expensive loans – it is weak consumer confidence.
Bright spot
Now, let us turn to the bright spot – China’s stock market.
Chinese equities have outperformed the US and many global peers this year. The CSI 300 is up 17% while the MSCI China index is up 27% YTD in USD terms.
Within the MSCI China, communication services (+9.1%), consumer discretionary (+5.6%) and financials (+4.8%) have led the performance. The Hang Seng index is up 25% YTD in USD terms, with Hong Kong seeing a record $90bn inflow from the mainland H1.
This rally, despite weak macro data, seems to have been driven more by government intervention than earnings strength. State-backed equity purchases and a surge in corporate buybacks have supported prices.
Central Huijin Investment, a sovereign wealth fund, injected RMB 198bn ($28bn) in Q2, mostly into ETFs tracking the CSI 300. Announcements of anti-involution policies and further stimulus have buoyed sentiment. Higher liquidity from lower rates and high household savings, along with capital shifting from property to equities, has also helped.
On the company side, Chinese firms are delivering earnings per share (EPS) growth of around 10% YoY — the first time in seven years this aligns with expectations. However, revenues have been flat for nearly three years. EPS gains stem from margin expansion (non-financial net profit margins at 5.3%, near a 14-year high) and buybacks, which hit record levels in 2024.
Both drivers now show signs of fatigue: manufacturing overcapacity pressures margins, and buyback activity is slowing, raising concerns about the sustainability of earnings growth beyond 2025.
Although the trade war has caused periods of volatility, its impact on Chinese equities seems to have been short lived and relatively minor.
China has adapted by diversifying supply chains and tariffs have been less severe than feared – currently 30% versus Brazil and India at 50%. In fact, uncertainty has attracted foreign capital, boosting markets.
So, which side of China’s two tales will ultimately prevail?
So far, the stock market rally seems to have been driven more by sentiment, policy support and liquidity than by earnings growth or economic fundamentals. The absence of a clear rebound in the economic data raises questions about the rally’s sustainability.
The scale and effectiveness of policy measures going forward will be crucial. While past rounds of stimulus seem only to have had a limited impact on deflation and pricing pressures, larger stimulus could act as the driver for sustained market momentum.
Alternatively, investor disappointment in the measures taken, or their continued ineffectiveness, could be the trigger for a market correction.
