Want to jump into the ‘China is back’ rally? Tread carefully

“China is back” is a common refrain among investors, who point to the success of the country’s key AI companies and its economy’s ongoing recovery from a three-year deflationary scare. But picking stocks in China remains as difficult as ever. China certainly seems to be coming out of its slump. Gross domestic product in the first quarter rose 5.0% year-over-year, up from a three-year low of 4.5% in the fourth quarter, supported by strong manufacturing and exports. Although high-tech manufacturing helps offset this barrier, consumer spending remains erratic and real estate continues to decline. Beijing’s efforts over the past decade to improve the country’s economy by investing in advanced technology, green energy and high-end manufacturing have clearly paid off.

These efforts are also evident in the Chinese stock market.

Three of the eight sectors on Hong Kong’s list that outperformed the market through mid-May – industrial, technology and process industries – are at the intersection of Beijing’s policy priorities. Performance varies sharply across the industry. BYD and Geely, China’s two largest electric vehicle manufacturers, increased by 2% and 19% respectively in the year to mid-May, driven by premium products and strong exports. Smaller rivals Xiaomi and XPeng are down more than 20% during this period, weighed down by margin fears as the price war in the industry intensifies.

It is clear that artificial intelligence is one of Beijing’s key priorities and a key driver of stock market performance. However, since “artificial intelligence losers” have also emerged in China, it is necessary to be careful here too. Following the launch of Anthropic’s Claude AI platform in early 2026, shares of some Chinese platforms providing tourism and online music services (including Trip.com and Tencent Music) fell and never recovered. Meanwhile, some policy-targeted sectors underperformed. Technology services, home to AI giants Tencent, MiniMax and Baidu, were down 17% in the year to May 15; This reflects investor concern about high development costs, intense competition and doubts about short-term profitability. Investing your money in market leaders didn’t always work either. China’s largest chipmaker, SMIC, fell more than 5% in the year to mid-May due to concerns about heavy capital spending, while smaller rival Huahong Semiconductor rose a stunning 56%.

Involution solution

Another key priority for Beijing over the past year has been eliminating “involution,” the overcapacity and deflation caused by weak domestic demand and unregulated, excessive competition. However, the mixed results have created both opportunities and pitfalls for investors. Nowhere is evolution more evident than in EVs. The discounts keep coming, almost a year after Chinese officials warned EV makers to end vicious price wars. Throughout 2026, major manufacturers have offered price cuts of 10% to 15% in the face of excess capacity and declining auto sales.

Investors may therefore consider avoiding the “losers of the revolution,” who tend to continue to bear the brunt of this fierce competition. But this is easier said than done.
One option would be to focus on companies that take pressure off their domestic margins by increasing high-value exports. Geely and BYD both appear to be in this camp and have expanded aggressively abroad in recent years. BYD recorded a 56% annual increase in exports in the first quarter of 2026, while Geely recorded a 126% increase. Of course, for companies to successfully pursue this strategy, they will need to overcome geopolitical fault lines in a world of increasing trade barriers. Companies that successfully locate production facilities abroad and focus more broadly on the international market may be better positioned; because this strategy can enable them to both overcome trade frictions and capture global margins, rather than risk being dragged into a “race to the bottom” in the local Chinese market, where demand remains muted. BYD’s facilities in Hungary, Brazil, Türkiye and Thailand could serve this purpose. So could Geely’s European factories and planned acquisitions in Mexico. Battery leader CATL is following suit with its giant factory in Hungary.

Politics wins

Beijing’s other efforts to boost efficiency and innovation are also bearing fruit. In the solar industry, for example, government-encouraged consolidation has driven more than 40 small firms into bankruptcy or acquisition; this rationalized a bloated industry. Shares of large, vertically integrated solar companies have benefited from consolidation; industry leader Jinko Solar has increased by more than 20% in the last 12 months. Meanwhile, in the biotechnology space, the National Medical Products Administration (NMPA) implemented faster approval timelines and aligned its standards with international organizations such as the International Council for Harmonization in July 2024. The resulting acceleration in clinical trials and an increase in deals in which global pharmaceutical companies license the rights to commercialize Chinese-developed products elsewhere have sent Chinese biotech ETFs sharply higher this year.

In China’s massive market, numerous positive factors are evident, many of which may be permanent.

However, risks should not be ignored. Rising geopolitical tensions with the United States could potentially lead to higher tariffs and export restrictions. Unregulated competition can rear its ugly head even in industries that are seeing the nascent benefits of the “anti-involution” drive. China may be back, but policy and news-driven volatility has not gone away. Therefore, investors need to be careful and exercise due diligence.

(The views expressed here are those of Manishi Raychaudhuri, founder and CEO of Emmer Capital Partners Ltd and former head of Asia-Pacific Equity Research at BNP Paribas Securities.)