China remains under-appreciated and under-valued

While improving geopolitical and economic conditions have buoyed equities, China’s innovation and long-term potential are yet to be fully recognised

It’s a time of reawakening for the Chinese stock market. Over the past 18 months it has rallied, bringing three years of poor performance to an end as the difficulties that overhung the market start to lift. But while not as cheap as it was, we believe that the market remains under-valued.

Illustrating how the cloud that hung over Chinese stocks has recently begun to lift, the MSCI China Index has risen by 38.8% in 2025 to date¹. That follows on from a buoyant year in 2024, when the index returned 19.4%. But the previous three post-COVID years each recorded double digit losses.

Sentiment is shifting, and justifiably so. The factors that had held the market back – tense geopolitics, domestic regulation, a subdued residential property market and poor corporate governance – are generally improving.

At the same time, though, we believe that the innovation and likely growth within key sectors of China’s economy have yet to be fully appreciated. When visiting companies, our local experts are impressed by the technology innovation and competitiveness of industrial companies and excited by the prospects for future domestic consumption. As managers of the Fidelity China Special Situations investment trust, it’s our job to deliver broad exposure to the long-term potential of these Chinese equities.

An improving geopolitical and economic situation

Chief among the factors overhanging perceptions of China has been geopolitics and specifically the trade war with the US. However, October’s agreement to a one-year tariff truce between presidents Trump and Xi has cleared up some of the uncertainty that markets hate. What’s more, talk of the US and Chinese economies decoupling has lessened amid recognition that they are intertwined.

Turning to China’s domestic economy, the government went through a cycle of tightening regulations that concerned international investors. But following a period of relative economic weakness, the government is focusing back on growth. October’s Fourth Plenum offered a glimpse of the Communist Party’s thinking, reiterating its long-term economic goals.

A major problem weighing on the economy was residential property’s multi-year slump. Policymakers have recognised the importance of this and introduced support measures. This has reduced the surplus supply of property. Furthermore, new measures including mortgage rate cuts, relaxation of housing purchase restrictions and funding support have been announced at city and national level to support property demand. As a result, the prospects look better for pricing, especially in first-tier cities.

Lastly, corporate governance is getting better. A chart of company dividends and share buy backs would be like Japan’s, where there is far greater appreciation of progress. Companies are handing cash back to shareholders.

Technology innovation, moving up the industrial value chain and the consumer growth story

While China’s recent problems have been well-publicised, our job is to find its overlooked corporate growth stories. A major theme for the trust is technology innovation. Every day we see how competitive they are. Chinese private companies have increased research and development spending at 20% a year for the last 15 years. We should not be surprised by the breakout of DeepSeek or any other emerging leaders in the humanoid robot and other innovation themes.

Their scale and the comprehensiveness of the ecosystem are also under-appreciated. Consider that China produces 60-70% of the world’s electric vehicles (EVs) and that half of the cars sold in the country are EVs. What’s also not appreciated is the scale in related areas like batteries and key component suppliers. Companies in the rest of the world will have trouble competing and rebuilding their ecosystems in the short term. It’s true that industries such as EVs have over-capacity but the process of consolidation is already taking place. China’s industrial and manufacturing companies are climbing up the value chain and gaining market share in machinery, automation and high value-added industrial components.

Another theme is the consumer, amid China’s emphasis on the domestic economy. Consumer stocks have been out of favour, but household finance is in good shape and consumer confidence is showing some signs of improvement, especially as real estate prices stabilise. We remain excited about what we see as a structural growth story, especially as policymakers vow to boost domestic consumption in their policy goals. Just consider that sportswear spending is about a tenth of its level in the United States. With consumer stocks trading at cheap valuations, there’s significant potential within experience-based consumption, travel and sportswear.

Investing against the consensus

But anyone thinking of investing in China should be comfortable going against the consensus. While China accounts for about 17% of the global economy, it only makes up about 3% of global stock markets². I prefer to go against the consensus because you have the potential for sentiment to swing your way over time as the strength of the market is recognised. The trust currently has a net gearing level of 19.6%, showing that its borrowings are on the high side of history, reflecting the exciting investment opportunities we find.

Would-be investors should also be comfortable with volatility. Although we expect the future direction of government policy to support the economy, China regularly features in the news, and the news stories can drive short-term fluctuations in its stock market.

But this does not change the long-term potential of Chinese companies. Their competitiveness is under-appreciated, which is why stocks remain under-valued. Over time, it is their ability to drive earnings growth that should propel the trust’s net asset value and, hopefully, its share price as well.

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