New drivers steering China equities

DESPITE the strong recovery in both onshore and offshore China equities over the past two years, investors have largely remained underweight, unconvinced that the stock market rally is sustainable.

On an asset-weighted basis, global active mutual funds underweight China by 340 basis points (bps) versus their benchmarks at the end of September 2025 (versus underweight by 320 bps at the end of June 2025).

Investor scepticism has kept valuations at discounted levels compared to developed markets.

Even after the recent gains, MSCI China trades at 13.3 times forward price-to-earnings, marginally above its 10‑year average. When compared to other key global market indexes, the MSCI China Index is trading at over 20% below its peak in 2021, while others have reached or exceeded their peak valuation in recent years.

It is convenient to argue that China remains “cheap for a reason,” yet this overlooks the shifts that are underway. China’s macro narrative is shifting in a more deliberate way.

Rather than relying on broad-based stimulus, policy support will be geared towards higher-value industries and long-term tech self-sufficiency as recommended in China’s most recent 15th Five-Year Plan, 2026-2030.

Reshaping the opportunity set

The plan emphasises deepening China’s ability to innovate and accelerate breakthroughs in artificial intelligence (AI), semiconductors, advanced computing, biotech, next-generation materials, satellite communications, and clean energy systems.

These sectors are at the forefront of China’s mid- to long-term growth model.

Supply chain security and industrial resilience also feature prominently in this plan.

China aims to localise critical technologies, reinforce strategic manufacturing capacity and modernise traditional industries, creating opportunities for domestic champions and realising self-sufficiency in key sectors.

In parallel, the plan recommends bolstering domestic demand by placing greater emphasis on sectors such as healthcare, elderly care and service consumption – segments that have seen structural underinvestment and now offer multi‑year growth potential.

Collectively, these policy priorities are reshaping the landscape of investment opportunities and creating a conducive environment for active stock selectors.

Equity themes to monitor

A key theme in our view is the accelerating execution of anti-involution measures after the National People’s Congress in March. This supports a healthier competitive environment and bodes well for earnings growth; consensus estimates for earnings per share are around 13% in 2026 – placing China in the upper tier of Asia-Pacific markets.

AI remains a dominant multi-year theme, but China’s AI advancement is under-appreciated. With global AI capex set to rise meaningfully in 2026 and beyond, there will be strong demand for China’s upstream hardware suppliers, which offer the scale, speed and pricing, supporting global customers’ need to build computing power and data centres with efficiency.

Local AI beneficiaries and early AI monetisation proxies that emerge as winners in the ongoing market consolidation phase should also attract investor interest.

Financials also feature as another theme. In particular, non-bank financials such as life insurers serve a key role in delivering steady returns to policyholders, especially when there’s a significant amount of household time deposits that are maturing this year.

Yet another theme to monitor is domestic consumption which is expected to experience a K‑shaped recovery, with resilience in the luxury segment.

Service‑led consumption, spanning healthcare, leisure, wellness and experience‑based spending, stands out as a key structural growth area.

Game-changing catalysts

Chinese households’ US$22 trillion in deposits could be a powerful catalyst for equity markets.

With property investments losing appeal and deposit yields declining as deposit rates fall, more of this liquidity is expected to migrate into alternative areas including equities.

The next move from the People’s Bank of China would likely be an interest rate cut in the second quarter of 2026. Such a move, along with the US Federal Reserve’s additional rate cuts, could mean further share price upside for Chinese stocks.

In addition, with increased new life insurance premiums, there could be more capital flowing into China’s equity market. Chinese policymakers have issued guidance to encourage insurers to take a longer‑term role in the equity market.

Lastly, we believe that some of the negotiated tariffs have swung too far, and if the United States begins to face higher inflation, the administration could be forced to unwind some of these trade actions.

This in turn could ease pressure on Chinese exporters, support China’s industrial economy, and lift both sentiment and capital flows into China’s equity market. A more constructive global macro backdrop as well as monetary and fiscal easing will be conducive for the equity market in 2026.

Opportunities amid the risks

The China market could stay volatile. We are cognisant that the market’s significant rally in the last two years has increased a near-term risk of a potential correction, possibly driven by near-term overbought sentiment, and high expectations on growth resilience.

An increasingly unpredictable geopolitical environment could add further volatility; US-China trade frictions are likely to persist but might have passed the worst times in the run‑up to the November US mid‑term elections. No political party is likely to secure easy wins if the US economy is under pressure from rising inflation and tariff risks.

We believe China equity markets could continue to rally in 2026, albeit at a more gradual pace given that valuations are fair while still at a notable discount versus the developed markets.

We believe a depreciating US dollar, investors’ low expectations for stimulus policy, and the market’s attractive earnings growth potential are all supportive factors.

The rally is also likely to be more sustainable and supported by genuine tech breakthroughs, targeted government backing, consistent buying from domestic investors and increased probability of improving foreign inflows.

We remain focused on fundamentally sound companies with reasonable valuations and credible growth, while avoiding firms burdened with national‑service mandates. We target global and national champions, including those within the tech and advanced manufacturing sectors.

Equally, a “barbell” approach of having both defensive and growth compounders in our portfolio allows for nimble positioning.