High risk, high reward: the case for (and against) China

It’s been a bumper few months for Asian stock markets. They have outpaced both a resurgent S&P 500 and the MSCI World. At the heart of this strength has been a revival in the Chinese market, with the Shanghai Composite index up over 12% since the start of April*. 

Are Chinese equities finally starting to shake off their recent dry spell – with consequences for the rest of Asia? 

The recent history of China is well documented. Three years of grim stock market performance were brought to an end by signs of a turnaround in the country’s economic fortunes and a significant stimulus package from the Government. However, there remain lingering concerns over the impact of US tariffs, even though both sides have rowed back from more extreme positions. There is also a persistent sense among some investors that China is ‘uninvestable’ – it lacks transparency, the government is prone to interference, and it has some dubious allies. 

Innovation and opportunity 

China remains a complicated investment case. It undoubtedly has some incredible companies and is the world leader in many technologies, including electric cars and battery technology. The team on the M&G Asian fund gives the example of wind technology: “China is making waves in the offshore wind energy industry. In 2023, the country commissioned 6.3 gigawatts of offshore wind development, leading the world for a sixth year in a row, accounting for nearly 60% of total additions to the sector worldwide, and bringing its own total offshore wind installations to 38GW capacity – 11% higher than Europe and underscoring China’s dominance in this field.”

In AI, it appears to be moving from being a magpie of other countries’ technology to generating real innovation. The launch of Chat GPT rival DeepSeek was just the start. There are also battery businesses such as CATL, which are pushing innovation. Huawei is now actively deploying its own AI chips and systems and is rapidly catching Nvidia.

All this comes at a fraction of the price of their equivalents in the US. China bulls would ask why an investor would buy Tesla, with all its complexities, when they can buy BYD for a fraction of the price. BYD’s sales are nearly triple those of Tesla and have greater momentum**, while Tesla is about to lose some of the tax credits that have helped propel its profitability to date. 

On tariffs, there are still vulnerabilities, but as the team on the T. Rowe Price Asian Opportunities Equity fund says, China has made significant strides to diversify its economy. “The Belt and Road Initiative has broadened access to global markets, diversifying trade partnerships, while the “dual circulation” strategy has fortified domestic economic resilience. Additionally, breakthroughs in critical technologies have eased supply-side bottlenecks, and deleveraging in the financials and real estate sectors has reduced systemic risks, positioning China to better absorb potential shocks.

“The economic impact from tariffs is moderated by China’s reduced reliance on US markets. In 2024, exports to the US (including re-exports) accounted for approximately 3% of China’s gross domestic product (GDP), down from 6% in 2010, reflecting a significant shift in trade dynamics.”

On top of this, Chinese markets are still cheap on most measures. The forward price to earnings ratio for the MSCI China is just 11.45x, compared with a lofty 18.7x for the MSCI World index***. Against this backdrop, it is easy to paint a scenario where China rallies from its currently depressed levels and is one of the best-performing markets in the world over the next 12 months. 

Risks, geopolitics and the case for caution

Nevertheless, there are still serious risks. China is posing an increasing threat to the US on the world stage. The country is building an impressive naval fleet. In a recent report to Congress, US Naval Institute staff reported that “the overall battle force [of China’s navy] is expected to grow to 395 ships by 2025 and 435 ships by 2030. The U.S. Navy, by comparison, included 296 battle force ships as of September 30, 2024.” The ambitions are clear. 

There are also the ongoing tensions over Taiwan. Trump’s bluster over his extra-territorial ambitions for Canada, Greenland and the Panama Canal may have encouraged the Chinese government to be more aggressive in its annexation of Taiwan. 

However, while these factors have the power to affect sentiment towards the US, they are unlikely to affect Chinese companies significantly. The problem is their impact on relations with the US. The more powerful China appears, the more the US will look to suppress it economically. This could bring further tariffs and trade wars, which would affect Chinese companies directly. 

There is also the problem that most Chinese companies are still relatively poor quality and have yet to show they can deliver reliable returns on capital. They may not be run for shareholders, but rather for a smorgasbord of national interests. Small foreign shareholders risk becoming collateral damage. 

The demographics of China are also a headwind. The one-child policy has left a damaging legacy and the working population is peaking. China needs to get rich before it gets old. The example of many Western nations shows how difficult it can be to generate economic growth amid an ageing population. 

The rest of Asia is large and diverse enough to cope without a resurgent China. Managers such as Jason Pidcock on the Jupiter Asian Income fund have managed to deliver strong returns without going near the Chinese stock market. India is growing fast, while Taiwan and South Korea are hotbeds of technological innovation. However, there is no doubt that a stronger Chinese economy and stock market could galvanise the broader region. China is around one-third of the MSCI Asia ex Japan index***. 

China has become the archetypal high-risk, high-reward stock market. As investors’ experience in Russia has shown, rogue actions by governments can see investors lose a lot of money very quickly. While it seems unlikely that the Chinese government will be similarly hot-headed, it remains possible. There are potentially high rewards in China, but the risks should not be under-estimated. Careful stockpickers, either focused on China, such as the Allianz China A-Shares fund, or on the broader Asia region, such as M&G Asian or T. Rowe Price Asian Opportunities Equity, are the best way to balance this opportunity. 

*Source: MatchWatch, Shanghai Composite Index, 8 April 2025 to 8 July 2025

**Source: Investors’s Business Daily, 7 June 2025

***Source: index factsheet, 30 June 2025