Markets Weekly: Is China Turning Things Around?

While the US S&P 500 struggles, weighed down by trade war fears and a darkening economic outlook, Chinese stocks are surging. Is the market witnessing a "Great Rotation" of capital, as investors shift their focus from the long-dominant US market to a resurgent China?

There's some early evidence that the narrative has flipped. The S&P 500 is down over 4% this year, a stark contrast to Hong Kong's Hang Seng Index, a key gauge of Chinese corporate performance, which has soared by nearly 20% since the start of 2025. This marks a dramatic reversal from the past few years, when US equities consistently outperformed their global counterparts, fueled by the momentum of "American exceptionalism."

US's Economic Uncertainty

Several factors are driving this shift. In the US, President Trump's aggressive trade policies have created significant economic uncertainty. Fears of slower growth and persistent inflation are weighing on investor sentiment.

JPMorgan now sees the chance of recession at 40%, up from 30% at the start of the year, warning that US policy was "tilting away from growth". Similarly, Moody's Analytics, upped the odds from 15% to 35%, citing tariffs as the main reason.

As tariffs and economic uncertainty continue to weigh heavily on sentiment in the US, investors are increasingly turning their attention toward China, where the economic narrative shows signs of improvement.

China's Rebound

After years of regulatory crackdowns and economic headwinds, China appears to be turning a corner this year. The government has unleashed a series of stimulus measures, including plans to expand the fiscal deficit, aiming to boost domestic consumption and investment.

Alongside the government's stimulus efforts, China's thriving technology sector has provided another catalyst for market optimism. The emergence of DeepSeek, a Chinese AI startup whose advanced, cost-effective, and open-source models rival those of OpenAI, has significantly boosted confidence in China's technological capabilities and sparked a major revaluation of Chinese tech stocks. Alibaba's shares have surged 61% since the start of the year, while Tencent has climbed 23% over the same period.

This renewed optimism is reflected in capital flows:

Inflows for Chinese securities investments jumped to a record high of $228.1 billion in February, as per data released by the State Administration of Foreign Exchange on Monday. After offsetting outbound flows, the net balance flipped to positive for the first time since September. (Bloomberg)

As well as bond yields:

Chinese bond yields have also bounced off record low levels as bearish bets on the economy take a backseat.

Another key factor driving this shift is valuation. Chinese stocks, after years of underperformance, are significantly cheaper than their US counterparts. The Hang Seng Index trades at a mere 7 times projected 12-month earnings, compared to 20 times for the S&P 500. This valuation gap, combined with the improving outlook for China's economy and the fading "American exceptionalism" narrative, is making Chinese equities increasingly attractive. As Michael Gayed, publisher of The Lead-Lag Report, put it:

I think China’s market is going to outperform the US markets for the next four years, and I don’t think it has anything to do with Trump. I think it has everything to do with starting valuation

Is China Out of the Woods?

Despite the emerging optimism surrounding Chinese equities, significant questions remain about the health of China's underlying economy. A number of economic headwinds still buffet the country. Deflation, high unemployment (particularly among youth), and a protracted real estate slump continue to cast a shadow over China's recovery.

Last month, China's consumer price inflation fell into negative territory, marking the first such occurrence in over a year. Producer price deflation has continued for over two years. This deflationary environment signals overcapacity and weak domestic demand, and is likely to persist for some time:

The current deflationary cycle in China thus has some important nuances. Although the problems of overcapacity in industry appear to be concentrated in certain sectors of the economy, such as the chemicals and metals industries, they have major ramifications for other economic sectors. On the other hand, in sectors such as textiles or durable consumer goods (such as the automotive sector), the episode of falling prices could be explained rather by stagnating domestic demand.

Also, despite localised problems, chronic overcapacity problems in industries at the beginning of the value chain will continue to apply pressure on prices downstream, i.e. in sectors that use these products as production inputs. Similarly, the real estate crisis will continue to apply negative pressure on prices and on Chinese consumer demand. In this regard, inflation in China is likely to remain close to zero in the coming years. (CaixaBank)

The property sector, a major pillar of the Chinese economy, also remains in crisis. New home prices have fallen for 21 consecutive months, and investment in real estate development continues to slump.

These challenges highlight the fact that China's economic recovery is far from complete. The stock market rally may be driven by specific factors (AI, valuation, capital flight from the US), but it doesn't necessarily translate to a broad-based improvement in the economy.

Long / Short

Cash Holding: "Powell’s message helped reassure equity investors. It also serves as a reminder of the need to optimize cash holdings. Cumulative returns on stocks (S&P 500) are more than 200 times higher than for cash since 1945, underlining that the long-term underperformance of cash is a structural phenomenon. In our view, the importance of putting excess cash, money-market-fund assets, and expiring fixed-term deposits to work has continued to grow this year." (UBS)

US Dollar: "We still think a lot of Fed-related negatives are already in the price of the USD. We also believe that the FOMC would disappoint the rate expectations for 60bp+ cuts this year. This, coupled with evidence that the Trump trade has been unwound by FX investors, could suggest that the recent USD sell-off could slow down in the near term." (Crédit Agricole)

Commodities: "What we’re going to start to see is... they’re going to price in a security premium to make sure you have that supply in your country. You’re seeing it in gold and you’re seeing it across the metal space. And I think that’s going to be the primary driver of the new cycle in commodities." (Jeff Currie, Carlyle)

Quick Hits

• Household Savings Dwindle: US households are running out of emergency funds as pandemic-era savings deplete and inflation persists.
• Fed's "Blind Flight": A former NY Fed President says the Federal Reserve is "flying blind" on growth and inflation, highlighting policy uncertainty.
• Fed Sees Stagflation Scenario: The Fed anticipates higher inflation combined with economic growth below 2% this year, raising stagflation concerns.
• OPEC+'s Production Plan: OPEC+ issues a new plan for oil cuts to compensate for overproduction, a key move for global oil markets.
• Accenture Feels the Pinch: Accenture warns of contract cuts, causing shares to dive, and becoming the "first corporate casualty" of DOGE.