Executive summary:
- There are some tentative signs of improvement in China’s beleaguered property market, but consumer confidence remains very low.
- We estimate that the 10% tariff the U.S. recently implemented on Chinese imports could create a 0.3-percentage-point drag on China’s GDP growth.
- Our outlook for Chinese equities in 2025 is marginally positive.
- Consumer behavior and the evolution of China’s trading relationship with the U.S. are likely to be the main forces that shape how the year unfolds.
2025 is beginning in much the same manner as 2024, with investors focused on whether the Chinese government is going to implement new stimulus measures. This year, however, there are two new developments: the release of the DeepSeek AI (artificial intelligence) model and the initiation of U.S. tariffs on Chinese exports. Amid this backdrop, we believe investors should focus on consumer behavior, the government’s reaction to economic conditions, and the evolution of the U.S.-China relationship.
Property transactions tentatively improving
The property sector remains the key drag on China’s economy—developers are still under pressure, while consumers are cautious on buying property. However, we are seeing tentative green shoots in recent transaction data for secondary homes, suggesting that all the supportive measures put in place through 2024 might be starting to bear some fruit.
However, it is important to highlight that it is not all improvement on the consumer front. Consumer confidence is still very depressed and is close to the lows of the last four years. Additionally, the economy continues to flirt with deflation, which could become a significant headwind if deflation expectations become entrenched. This would lead to consumers delaying the purchase of major goods due to anticipated further price declines.
Source: LSEG Datastream, Jan. 31, 2025
Policy reaction to tariffs remains unclear
As we head further into the year, the focus will be on the National People’s Congress meeting in March, where the government will announce its economic growth target for the year as well as any new policy measures. In our view, if an economic growth target of around 4.5% is announced, it will likely have to be accompanied by a more meaningful stimulus measure.
Another key watchpoint for Chinese policy will be the reaction to the 10% tariff rate put in place by the U.S. on Feb. 4. So far, China has responded by placing tariffs on $14 billion of U.S. imports, included coal, crude oil, liquified natural gas (LNG), and farm machinery. These tariffs went into effect on Feb. 10.
It’s important to note that while the 10% U.S. tariff rate on Chinese products is lower than many had feared, we estimate it will still create a drag on GDP (gross domestic product) growth of around 0.3 percentage points. The U.S. is set to complete its trade policy review by April 1, and we expect that China will be quite constrained in retaliation before that period is released.
AI advances have been impressive, but chips likely remain a constraint
There has been a lot of focus on AI developments in China, with Chinese startup DeepSeek reporting that it has achieved significant gains at a small cost. In the same week that DeepSeek made its announcement, there were three announcements from other companies in the country (Bytedance, Moonshot and Alibaba), all of which illustrated impressive improvements. This reflects the high level of competition that occurs in China—as proof, one can simply look at the rapid innovation and reduction in costs that Chinese electric vehicles have seen over the last four years.
Moving forward, we are likely to see more focus on efficiency from Chinese AI developers. However, further improvements to both capabilities and scale will likely prove challenging, given the export embargoes that the U.S. has put on major chip manufacturers. Reflecting these concerns, the founder of DeepSeek recently noted in an interview that the main challenge for the company is not funding but securing the necessary computing power (i.e., chips).
What are the potential market implications?
At Russell Investments, we use a cycle, valuation, and sentiment framework to guide our investment decision-making process. Using this framework, our outlook for Chinese equities is marginally positive.
Starting with the business cycle, whilst there is quite a bit of uncertainty around the economic outlook, Chinese companies have continued improving their return on equity (as shown in the chart below). Analysts are looking for about 9% EPS (earnings-per-share) growth through 2025, which seems achievable if the economy can achieve GDP growth of around 4.5% and corporates see some margin expansion.
Source: LSEG Datastream, Dec. 31, 2024
From our vantage point, valuations for Chinese equities continue to look reasonable, both on an absolute basis and relative to other emerging markets. Forward multiples are at an undemanding 10 times, while the so-called PEG ratio (or price-to-earnings-to-growth ratio—i.e., the earnings multiple divided by the long-term growth estimate) is at the 15th percentile relative to history.
Our sentiment measure is currently very neutral right now, after having been overbought in the second half of 2024 on expectations of further stimulus. This will be a key watchpoint through this year, especially as the market digests geopolitical and policy developments.
Source: LSEG Datastream, Bloomberg, Russell Investments, Jan. 24, 2025
Finally, it is worth touching on the Chinese yuan. Given the potential headwinds of tariffs, we think it is likely that we might see a bit more downward pressure on the yuan through this year. Conceptually, this has two benefits for China—the first being that it helps with alleviating some of the hit to competitiveness.
The second, and less obvious, benefit is that it could provide some upward pressure to imported prices—which could potentially help push the economy away from deflation. However, this pressure is likely to be limited and controlled, given China is also in the process of trying to internationalize the yuan—and therefore does not desire big swings in currencies.
The bottom line
The Year of the Snake is shaping up to be an interesting year for China. Market expectations are fairly subdued at this point, which presents some potential asymmetry—especially if chatter around the potential for additional stimulus picks up again.
Ultimately, we expect that consumer behavior and the evolution of the U.S.-China trading environment will be the main forces that drive how 2025 unfolds. We will continue to keep you updated as the year progresses.
Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.