China’s Stocks Are Flying as Beijing Doubles Down on Tech. Why the Economy Is Still Struggling.
China’s commitment to innovation poses a long-term threat to U.S. companies. What it needs now is for its citizens to spend more.
The future of robotics, biotechnology, and artificial intelligence is playing out in hundreds of fully automated labs across China managed by Hong Kong–listed biotech XtalPi Holdings. The company, founded in Boston by a trio of Massachusetts Institute of Technology–trained physicists, uses data generated in the labs to train AI models to accelerate drug discovery—garnering partnerships with Western pharmaceutical giants Pfizer and Eli Lilly.
XtalPi is still quite small, but the company’s story points to a major shift under way across China’s economy. Long known as the world’s factory, China is fast becoming a hotbed of innovation. In medicine, where the country was once content to manufacture drugs discovered elsewhere, it’s now developing new treatments for cancer, diabetes, and obesity. At the same time, it’s pushing hard for breakthroughs in aviation, robotics, semiconductors, and AI. DeepSeek, the Chinese AI company that shook global markets earlier this year, may only have been the beginning.
“When Chinese investors saw a homegrown AI answer to ChatGPT, it created this sense that China is a competitor—perhaps the only one—to the U.S. in terms of innovation,” says Philip Wool, chief research officer at Rayliant Investment Research. “That will be disruptive for Western companies.”
Already, China is putting up some big numbers. Its research and development spending has been rising by almost 9% a year, compared with 1.7% for the U.S., according to the latest data from the Organization for Economic Cooperation and Development. China filed 70,160 international patents in 2024, well ahead of the 54,087 filed by innovators in the U.S. China installed some 300,000 industrial robots in 2024, almost 10 times the number in the U.S., and it accounts for some two-thirds of all electric-vehicle sales.
The new dynamism has sent the country’s stocks flying. After a long slide, the MSCI China index is up 43% this year, more than double the surge of the S&P 500. Some money managers see further gains ahead, in both broad exchange-traded funds and specific stocks.
Yet all is not well in China’s economy. Far from it. Despite the burst of high-tech innovation, the economy seems mired in a long-term funk. Fixed-asset investment is contracting and retail sales growth is slowing, despite policymakers’ efforts to stimulate growth. China’s population has been shrinking for three years, and its property market has slumped for more than four years, taking the biggest store of household wealth with it. Mountains of debt weigh on the country. The upshot: Annual economic growth is expected to be down to 3% to 4% for the next few years, versus 6% to 8% in the recent past.
These two pictures of China—a rapidly advancing technological challenger and an economy in decay—aren’t as contradictory as they might seem. In fact, they are of a piece. Beijing had to do something about the bleak economy, and its old playbook of pouring money into infrastructure and construction projects to deal with economic slumps was no longer working. Plus, it needed to reduce its reliance on the West for critical technology as its rivalry with the U.S. heated up. It needed something new.
Beijing is turning sectors such as pharmaceuticals, semiconductors, and quantum computing into national strategic priorities and supporting them with heavy investment through subsidies and patient capital for research and development, as well as reforms that cut red tape. Bank of America estimates that China’s AI capital spending this year could total 600 billion to 700 billion yuan ($84 billion to $98 billion), with more than half coming from the government.
The high-tech push is sure to put pressure on U.S. companies. Think of it as the second China shock of this century. Much as China’s heavy investments in sectors such as steel contributed to the hollowing out of basic manufacturing in the U.S. and elsewhere after its entry into the World Trade Organization in 2001, China’s new initiative challenges advanced industries that are drivers of developed economies. That was clear in the strong hand that Chinese leader Xi Jinping played in trade talks with the U.S. last month, using the country’s dominance in rare-earth minerals and processing as a weapon.
China’s previous economic transformation left the country with a voracious appetite for commodities, cars, and capital goods. That, in turn, powered global growth. This time, China’s high-tech acceleration may end up much more one-sided, with benefits largely accruing to Chinese players—and those willing to risk investing in them.
Whether China’s new drive for innovation can seriously improve its economy is another question entirely. Signs of stress are everywhere: In a recent quarterly earnings call, China Merchant Bank highlighted an 11% decline in consumption among customers, retail loans under pressure, and the fact that 25 of the top 30 Chinese companies were caught in price wars.
Even if the country’s property downturn is nearing a conclusion, as some believe, whatever is left of the real estate sector will be a shadow of its former self, perhaps 40% of its original size, says Logan Wright, a partner at Rhodium Group. That will leave a gaping hole in the economy; property previously accounted for about a quarter of gross domestic product.
Beijing’s investment in AI, pharmaceuticals, and other advanced technologies likely amounts to under 10% of GDP and won’t fill the gap, says Wright. It is, however, a start. China’s commitment to tech exports recently prompted Goldman Sachs’ Asia team to raise its forecast for China’s GDP growth next year by a half-point, to 4.8%
China has seemed reluctant to take the strong medicine many economists suggest: initiatives to get Chinese households to consume more of the goods and services the country produces rather than relying on demand from the rest of the world. China provides 27% of global investment—the most of any country—yet accounts for just 12% of global consumption.
But there are signs that China may be ready to finally make some much-needed economic adjustments. In October, the Central Committee of the Chinese Communist Party unveiled a five-year road map that suggested it recognized the need to spur consumption—a notable shift. The road map hinted that policymakers may do more to get households spending, including directing more resources to public services. Already in the works: cash transfers to parents of young children and aid for families with disabled seniors.
“There’s a minimum level of economic activity needed to maintain social stability to be a superpower in technology and military—and with property tapped out and investments running into constraints and exports becoming unreliable, the only option is consumption,” says Rory Green, head of China research for TS Lombard. “It’s the last—and hardest—lever to pull, but they are finally recognizing it.”
Meaningful structural shifts clearly will require time and resources. For instance, the buildout of a safety net that would convince the Chinese people to save less and spend more could cost nearly a third of annual GDP, Rhodium estimates.
Meanwhile, China’s leaders hope they can sidestep those costly measures with a narrower bet on technology and industrial advances to lift productivity and ease the country’ ills, much like in the U.S.
China’s latest five-year plan urges policymakers to adopt “extraordinary measures” to fuel breakthroughs in critical areas such as semiconductors and high-end equipment and to break the country’s dependence on the U.S. and others while building on its leverage, such as in critical mineral reserves and resources.
“China can kill two birds with one stone by going ‘all in’ on technology and productivity strategies,” says Jorry Nøddekær, a fund manager for the Polar Capital Emerging Market Stars fund, who thinks the approach can help China become more independent of the West’s technology and repair its economy. Nøddekær says he has substantially increased allocations this year to new China economy sectors like the internet, advanced industrials, pharma, and biotech.
China’s ability to absorb tariffs and navigate U.S.-China tensions by flexing its dominance in rare earths left officials more confident that they can pull off the high-tech strategy, according to geopolitical consultants who have visited China in recent weeks. Indeed, China’s exports rose 8% in September compared with a year ago, even as the trade war prompted a 27% fall in shipments to the U.S.
Restrictions imposed by its adversaries are accelerating China’s push to innovate. China can’t surpass the U.S. and its allies in the most advanced semiconductors, which require technology from companies such as Nvidia and the Netherlands’ ASML. Their exports are tightly controlled.
But China is making inroads in midlevel chips and parts of the AI ecosystem, such as optical wiring, components, and other hardware. One example is China’s largest chip foundry, Hua Hong Semiconducto, which provides chips for a range of consumer technologies.
Global fund managers have a long list of companies they are tracking to keep tabs on China’s innovation, even some they are restricted from owning: DJI, on U.S. blacklists, is a leader in drones; Mindray, a medical monitoring and imaging company, is making inroads in markets once dominated by U.S. companies; and Geekplus specializes in autonomous mobile robots that have transformed warehouse fulfillment centers and the transport of industrial materials.
trategists and fund managers see the potential for a new bull market, even if this rally needs a period of digestion.
“What sets [Chinese companies] apart are extraordinarily lean operational cost structures, exceptionally tight value propositions for extremely demanding customers, and much shorter product iteration cycles compared with global peers,” says Zak Dychtwald, founder of research and advisory firm BridgeWorks Global. “The fierceness and price and cost demands of China’s markets make the winners emerging from here far more globally fit than most any other country’s environment will produce.”
Western businesses, for their part, face a triple whammy when competing with China. Chinese companies are nibbling at their market share in secondary markets such as Brazil and Australia and emerging as fierce rivals at home. In addition, their businesses in China are increasingly challenged amid rising tariffs, the risk of retaliation, slowing growth, and changing preferences. Starbucks said this week that it would sell control of its operations there to an Asian private-equity firm. The coffee giant, which entered China in 1999, has faced increasing competition from domestic rivals such as Luckin Coffee in recent years.
And while Chinese companies are going global, they are increasingly buying local. Policymakers are pressuring businesses to buy from domestic suppliers. For instance, Reuters reported this past Thursday that Beijing banned foreign AI chips from Nvidia, Advanced Micro Devices, and Intel from government-funded data-center buildouts.
That shift could keep trade tensions front and center. As companies such as electric vehicle-maker BYD move into advanced economies, policymakers there are pushing back with tariffs and taking a page from China’s industrial policy playbook. For instance, the U.S. is funding Intel and taking stakes in critical minerals companies. The Dutch government recently seized Nexperia, whose chips are used in cars and consumer electronics, on economic security grounds.
Similar moves worked for China and may help the U.S., says TS Lombard’s Green. But it will be difficult, he says, to “beat China at their own game where the system is set up for big top-down objectives, incentives are aligned, there are no elections, and policy is consistent.”
Geopolitically, recognition of China’s growing force in technology—of the risk of a second China shock—could reinvigorate global alliances as Western countries join forces to protect themselves. One recent example: U.S. deals with Malaysia, Australia, and Japan to find alternatives to China’s rare-earth dominance.
But while China can create headaches for global multinationals and Western policymakers, it may well create opportunity for investors as Beijing boosts spending in critical sectors.
Unquestionably, China’s stock market has come to life this year. Many foreign investors had deemed it uninvestible amid Beijing’s harsh Covid-era lockdowns, costly crackdowns on education and internet companies, and geopolitical tensions. But a stronger effort among policymakers to steady the economy, followed by innovation wins like DeepSeek, jump-started a powerful rebound last fall. The market is no longer dirt cheap, with the MSCI China now trading at 14 times next year’s earnings, but that’s still well below the S&P 500’s 22.5.
Chinese stock rallies often fade after a year or two—and this one is about to hit its first anniversary. But Gavekal analyst Thomas Gatley notes that trading volumes are higher now than when the rally started in late 2024. This rally, he notes, unlike previous ones, isn’t predicated on policy support from the government but rather on earnings improvements in sectors like those tied to AI.
Also encouraging: Chinese bank deposits total CNY165 trillion, compared with a stock market value of around CNY100 trillion, suggesting, says Gavekal, that a lot of money is sitting in low-yield deposits that could eventually trickle into stocks.
Gatley sees room for further gains, suggesting to clients in a recent note that they overweight China’s IT sector and companies like Tencent and Alibaba over the broader index. The iShares MSCI China Multisector Tech ETF is up 39% so far this year.
TS Lombard’s Green also sees more opportunity, especially with foreign investors still owning less in China than their benchmarks. Green takes legendary investor and longtime China bull Jim Rogers’ advice: Buy what the Chinese are buying—and right now, that is largely services. Meditation retreats and niche luxury brands, often domestic, remain popular, along with travel.
Of course, there’s one other thing Chinese households may load up on if Beijing succeeds in bolstering its economy and accelerating innovation: Chinese stocks. If domestic investors look to stocks as a place to park their cash, China’s stock rally could be more resilient than the one in the U.S.
