In brief
- Offshore Chinese equities have performed strongly year-to-date, driven by valuation re-rating and sentiment recovery from the AI tailwind. This represents a shift in near-term market leadership from “hard tech” to “soft tech.”
- The onshore A-shares market is more likely to benefit from domestic policy tailwinds in terms of stimulus, corporate governance reforms etc., and acts as a portfolio diversifier.
- The AI-driven rally in Chinese equities may be more sustainable than past upcycles, with technological advancements driving earnings and valuations. However, sustaining sentiment will require positive macro catalysts, such as domestic stimulus and U.S. trade relationship.
Chinese equities are off to a good start in 2025, driven by stronger-than-expected consumption data from the Lunar New Year holidays, milder tariffs from the U.S. than previously feared and the launch of multiple AI models in the span of a few days. However, market performance has diverged: onshore Chinese equities (MSCI China A Onshore) has been flat at a 0.28% return while offshore indices such as Hang Seng Index and MSCI China have risen 14.86% and 15.32%, respectively, year-to-date (YTD), on a USD total returns basis. In particular, there has been a surge of Southbound flows into the Hang Seng Index from Mainland investors, accumulating 185 billion Hong Kong dollar of net flows YTD in 2025, and Feb 18 representing a 4-year high. What has led to the divergence in performance and increased investor interest? Given the distinct drivers of Chinese equity returns, we explore the types of exposures that can allow investors to capture different opportunities.
Offshore Chinese equities buoyed by the AI tailwind
On January 27, the emergence of the Chinese AI start-up was seen as a credible competitor to AI leaders in the U.S., having trained its new model at a lower training/inference cost and with less advanced hardware than U.S. competitors. This created uncertainty surrounding the “hard tech” (e.g. semiconductors and electronic equipment) business models and raised questions about need for elevated level of AI related capex spending. On the other hand, the “soft tech” (e.g. software and information technology (IT) services sectors) are poised to reap the benefits from a faster pace of AI advancement. Specifically, the potential reduction in costs associated with inference and AI model deployment, which could greatly boost the adoption of generative AI within enterprises, will likely benefit software and IT services providers. As a result, this low-cost, high-performance Chinese AI model has contributed to a growing narrative of a possible shift in global market leadership from “hard tech” to “soft tech.”
This preference for soft tech over hard tech is also reflected in the performance of Asian technology stocks. Offshore Chinese equities have outperformed, given their greater focus on soft tech compared to the onshore China A, while the tech sectors in Japan, Korea and Taiwan are heavily concentrated in hard tech (Exhibit 1). The YTD outperformance of soft tech and offshore Chinese equities indicates a distinct rotation from late 2024 when hard tech, such as semiconductor stocks, clearly outperformed in the fourth quarter of 2024 (Exhibit 2).
Source: FactSet, MSCI, J.P. Morgan Asset Management. (Left) Based on MSCI China, MSCI China A Onshore, MSCI Taiwan, MSCI Korea and MSCI Japan indices. Hard tech refers to electronic equipment instruments & components, communications equipment, semiconductors & semiconductor equipment, and technology hardware storage & peripherals. Soft tech refers to IT services, software, interactive media & services, and broadline retail. Based on GICS industry classification. (Right) All data in USD terms. Includes companies under MSCI China and MSCI China A Onshore index.
Data reflect most recently available as of 17/02/25.
The rally so far has been driven primarily by valuation re-rating, helped by sentiment recovery and initial low investor positionings. In fact, the market-cap weighted valuation of the seven largest Chinese mega-cap tech stocks expanded 30% YTD, narrowing the valuation gap between them and that of the 7 mega-cap tech stocks in the U.S. (Exhibit 3), although the U.S. premium is still at a significant 1.7 times.
Exhibit 3: Valuation premium of U.S. over China’s mega-cap tech stocks still wide but narrowing*
Source: MSCI, J.P. Morgan Asset Management; Bloomberg. *U.S. mega-cap tech stocks are proxied by the 7 mega-cap tech stocks in S&P 500, namely Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, Tesla. China’s mega-cap tech stocks are proxied by the 7 stocks with the largest weights in MSCI China Tech 100 Index, namely Xiaomi Corp, JD.com, Trip.com Group, Tencent Holdings, Alibaba Group Holding, BYD Co, Baidu. Valuation premium is calculated by taking market-cap weighted average of U.S. mega-cap tech stocks’ forward price-to-earnings ratios divided by that of China’s.
Data reflect most recently available as of 17/02/25.
Looking beyond valuations, this AI tailwind has the potential to lead to higher revenue and margins, lower the entry barrier to invigorate competition, while enabling further geographical expansion of Chinese players. On an economic level, the potential for higher rates of productivity and a new capex cycle can help support China’s growth.
However, all of the above come with uncertainties at this stage. While the current rally is supported by a sentiment boost, its sustainability will hinge on these factors going forward:
- The ability of Chinese companies to access leading-edge foreign chips (given existing export restrictions) or become sufficiently self-reliant.
- The ability of AI developers to monetize this technology to support China’s mass AI adoption, such as through the integration with super-apps.
- The government’s attitude towards private businesses and AI developments after the notable meeting between President Xi Jinping and top tech leaders on Feb 17. Investors will likely focus on the follow-up actions of government agencies, and whether the actions will be substantive and prominent enough to boost private sector confidence.
A-shares’ domestic tailwind and diversification deserving attention
While the AI tailwind will likely benefit offshore equities more, onshore A-shares are more likely to enjoy policy tailwinds given their domestic focus. The index leans towards financials, industrials and consumer staples sectors (accounting for 54.2% of the index), which are more sensitive to domestic stimulus such as infrastructure spending, consumption support etc. Beyond stimulus policies, the A-shares market will also be the primary target for any equity market support from the government (e.g. initiatives to boost liquidity, increased equity allocations by financial institutions and direct stock purchases from the National Team).
The Nine Point Guideline introduced in 2024 also aims to enhance the quality of the A-shares market through capital market reform, encouraging higher dividend payouts and share buybacks, benefiting A-shares shareholders and attracting more capital into the market.
From a portfolio perspective, given China’s distinct policy and economic cycle, as well as relatively lower foreign investor participation, the onshore A-share market holds a lower correlation with global assets and thus is a better portfolio diversifier. For example, MSCI China A Onshore only has a 0.34 correlation with S&P 500, while offshore MSCI China has 0.47 (Exhibit 4). This indicates that the onshore A-share market is less sensitive to global risk sentiments and macroeconomic conditions.
Exhibit 4: Correlations between A-shares and global equities
Source: MSCI, J.P. Morgan Asset Management; FactSet, China Securities Index, Standard & Poor’s.
Data reflect most recently available as of 17/02/25.
Investment implications
After China’s covid reopening, the equity market had three notable bull runs—the National Team and property market stabilization measures rally in March 2024 (MSCI China price-to-earnings (P/E) peaking at 10.7x on 17/05/24), the surprise monetary easing and spending stimulus package rally last September (MSCI China P/E peaking at 11.9x on 04/10/24), and the current AI optimism fueled rally. Current valuations for MSCI China are at 11.3x, in line with the long-term average and still 33% from the previous high of 16.8x in early 2021.
While the previous upcycles were rather short-lived, we believe the current rally maybe different. Instead of being policy-driven, markets are gaining confidence in Chinese companies’ abilities to turn research expenditure into revenue. These technological advancements are primarily driven by innovation and are more favorable for valuations and a more sustainable earnings rally.
China’s continued AI advancement could potentially kick-start another round of private investment and hiring, providing more momentum to the economy. Of course, this could also mean that government support for the economy might be weaker than expected. However, we see a private investment-driven cycle as more sustainable and self-reinforcing, rather than relying solely on the government’s policy support.
Looking ahead, more positive macro catalysts such as stronger domestic stimulus, U.S. trade talk progress as well as better macro data/earnings will be needed to sustain investor sentiment.
The YTD rally has been narrowly focused. However, as the AI theme continues to permeate the broader economy, we could see some select A-shares start to benefit as well. This rotation away from high-dividend stocks to tech will require active stock picking focusing on company fundamentals.
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