Want to join the "China is back" rally? Raychaudhuri: Be careful!
Investors often repeat the phrase "China is back", pointing to the successes of the country's?artificial-intelligence companies, and its ongoing recovery from a deflationary slump of three years. Stock-picking remains difficult in China. China appears to be emerging from its slump. The first-quarter gross national product increased by 5.0% on an annual basis, compared to a low of 4.5% for the fourth quarter, mainly due to strong manufacturing and exports. The consumer spending is still patchy, and the property market continues to decline. However, high-tech manufacturing helps offset this. Beijing's efforts to?upgrade China's economy in the last decade by investing in advanced technology and green energy, as well as high-end manufacturing has clearly paid off.
The Chinese stock market is also showing signs of these efforts.
Three of eight Hong Kong listed sectors which have outperformed market performance through mid-May are industrials, technologies and process industries. These three sectors all fall at the intersection between Beijing's priorities. Performances within the same sector differ sharply. BYD, China's largest electric vehicle manufacturer, and Geely, its second-largest, were both up by 2% and 19% in the past year, boosted by high-quality products and exports. The smaller rivals Xiaomi, XPeng and Yingli fell by more than 20 percent in that period. Margin fears were a factor in this decline.
AI is clearly one of Beijing's top priorities, and it also plays a significant role in the performance of the equity markets. Here again, caution should be exercised as there are "AI losers", too, in China. After the launch of Anthropic’s Claude AI in early 2026 shares of Chinese platforms that serve tourism and online music – Trip.com and Tencent Music, among others – nosedived. They haven't recovered. Several policy-targeted industries have also underperformed. The technology services sector, which includes AI giants Tencent MiniMax Baidu, dropped by 17% between May 15 and the end of the year. This was due to investor concerns about high development costs, intense competitiveness and doubts regarding near-term profitability. It has not always been a good idea to put your money on the'market leaders. SMIC, China's biggest chipmaker, was down more than 5% for the year to mid-May due to concerns over heavy capital expenditures. Meanwhile, Huahong Semiconductor grew by a stunning 56%.
INVOLUTION SOLUTION Beijing has also been focusing on stamping out the "involution", which is overcapacity, deflation and excessive competition due to?soft domestic demands and disorderly competition. Investors have faced both positive and negative outcomes. In EVs, involution is most evident. Discounts continue to be offered almost a year after Chinese officials warned EV -makers to stop their fierce price battle. Top manufacturers offered price reductions of 10% to 15% throughout '2026 in response to massive overcapacity, and falling auto sales.
Investors should avoid the "involution losers", i.e., those companies that are likely to continue to bear the brunt of fierce competition. It is much easier to say than do.
One way to do this would be by focusing on companies who are expanding exports of high value and thus reducing the pressure on domestic margins. Geely, and BYD are both in this group. Both have aggressively expanded abroad in the past few years. BYD reported a 56% increase in exports year-over-year in the first quarter 2026. Geely posted a 126% rise. Companies will have to be able to navigate the geopolitical faultlines in an era of increasing trade barriers if they are to successfully pursue this strategy. The companies that are able to locate their production abroad and concentrate on the global market in a more broad sense may be better placed. This strategy will allow them to avoid trade frictions and capture global margins, rather than being pulled into a “race to the bottom” within the Chinese domestic market. BYD's factories in Hungary, Brazil and Thailand could be used for this purpose. Geely's plants in Europe, and the planned acquisitions of Mexico by Geely could also serve this purpose. Battery leader CATL has taken the same route with its gigafactory located in Hungary.
Beijing's efforts to increase efficiency and innovate are also paying off. For example, in the solar ?energy industry, government-encouraged consolidation has pushed more than 40 ?smaller firms into bankruptcy or acquisition - rationalizing a bloated sector. The consolidation has benefited large, vertically-integrated solar firms, and sector leader Jinko Solar's shares have increased by more than 20 percent over the last 12 months. In biotech, the National Medical Products Administration has accelerated approval timelines, and will align its standards with international bodies like the International Council for Harmonisation by July 2024. Chinese biotech ETFs have risen sharply this year due to the acceleration of clinical trials, and an increase in deals in which global pharmaceutical companies are licensed rights to market Chinese-developed products elsewhere.
China's huge market has a number of positive factors that could be durable.
Nevertheless, risks are not to be ignored. The rising geopolitical tensions between the U.S. and China could lead to increased tariffs and export restrictions. Even in sectors that are beginning to reap the benefits of "anti-involution", disorderly competition can still be a problem. China is back but the volatility caused by policy and news has not gone away. Investors should proceed with caution and do not cut corners on due diligence.
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(source: Reuters)
