Why the investment case for China is strengthening

China remains out of favour with many global investors, but improving earnings prospects, technological leadership and attractive valuations are strengthening the investment case. Dale Nicholls, Portfolio Manager of Fidelity China Special Situations PLC outlines why he believes the outlook for Chinese equities has become increasingly compelling.

China remains out of favour with many global investors. Concerns around domestic growth, the property sector and geopolitics have continued to weigh on sentiment, leaving many investors underweight the market. Yet, while these concerns remain, we believe the investment case has strengthened over the past year.

Global fund allocations to China remain well below benchmark, despite the country's significance within the global economy. While earnings growth has been relatively subdued over the past decade, valuations have fallen to levels that we believe do not fully reflect the long-term prospects for many Chinese companies. Today, the market trades on around 10 times forward price-to-earnings, well below its historical average and providing a big discount to some developed markets. In our view, this creates scope for both earnings and valuations to improve over time.

When discussing China, it is easy for the narrative to become dominated by macroeconomics and geopolitics. While these remain important considerations, we believe the more interesting story lies with the companies themselves. Across many sectors, Chinese businesses continue to invest in research and development (R&D), strengthen their competitive positions and gain market share globally. Those are the trends that continue to shape how we think about the opportunity set in China.

A two-speed economy

China's economy continues to operate at two speeds. Domestic consumption has remained relatively weak, while exports continue to provide the main engine of growth. Export demand has remained resilient, particularly across technology related sectors, while stronger imports have reflected the demand for components used in manufacturing. At the same time, we are beginning to see signs that capital investment is picking up, particularly in areas linked to artificial intelligence. China has lagged the US in AI investment, but this is an area we believe is worth watching as investment gathers pace.

Growth and real activities at two-speed

GDP by contribution

^{Source: Fidelity International, Macrobond, China National Bureau of Statistic (NBS), July 2026. GDP: Gross domestic product.}

Consumers reluctant to spend

Consumer confidence

^{Source: Fidelity International, National Bureau of Statistics, Macrobond, July 2026.}

While exports have supported growth, domestic demand has remained more subdued. Consumer confidence has yet to recover fully following the pandemic. Despite the relatively healthy household balance sheet, consumers are reluctant to spend, leading households to save more and borrow less. In our view, the issue is less about consumers' ability to spend but more about confidence.

Two factors are likely to be particularly important in rebuilding that confidence. The first is income expectations. Here, there are some encouraging early signs, with employment indicators beginning to improve. The second is asset prices, particularly housing. Property remains central to consumer confidence in China and continues to be one of the biggest drags on the economy.

Our view on the property market remains somewhat different from the prevailing consensus. Housing starts (an economic indicator that measures the number of new residential housing units where construction has begun) have fallen by around 80% from their peak, representing a significant adjustment in supply.  In our view, China is now approaching the later stages of that adjustment. While government measures have helped support demand through lower financing costs, we believe the more important adjustment has been on the supply side. Over time, this reduction in supply should help restore a healthier balance between supply and demand.

Importantly, we do not necessarily need to see a sharp recovery in property prices. Greater stability alone could help restore confidence and encourage a gradual recovery in consumption. Combined with healthier household balance sheets and early signs of improvement in employment, these developments suggest that parts of the domestic economy are beginning to evolve, even if the recovery remains gradual.

The macro picture therefore remains mixed, and we are not suggesting that China's economic challenges have disappeared. However, focusing solely on these issues risks overlooking the developments taking place beneath the surface. For us, the more compelling story continues to be found at the company level.

The overlooked strength of Chinese companies

Our confidence is grounded in what we continue to see at the company level. Across many industries, Chinese businesses are strengthening their competitive positions through sustained investment in research and development, manufacturing expertise and the scale advantages that come from serving one of the world's largest domestic markets.

Chinese companies have been investing heavily in research and development for many years. In our view, that has been one of the key drivers of their growing competitiveness. Although this investment has weighed on margins, it has delivered in terms of innovation and market leadership. And this is something we continue to see first-hand through our meetings with management teams and remains an important factor when assessing the long-term outlook for many businesses.

Growing competitiveness support by strong Research & Development (R&D)

Gross domestic expenditure on R&D

Billion US dollar, purchasing power parities (PPP) converted

^{Source: OECD, March 2026 statistical release with full-year 2024 data.}

Increasing R&D expense across sectors over long term

^{Source: Goldman Sachs Global Investment Research, May 2026}

Scale is another advantage that we believe is sometimes underestimated. Companies that can build products for China's domestic market benefit from production volumes, operational expertise and supply chain ecosystem that are difficult to replicate elsewhere. In many industries, this provides a strong platform for international expansion and helps explain why Chinese companies continue to gain market share globally.

We also see encouraging signs in the way companies are allocating capital. For many years, Chinese businesses were net issuers of shares. More recently, buyback activity has increased meaningfully while dividend payments have continued to grow, supported by corporate governance reforms that are placing greater emphasis on shareholder returns.

Where we are seeing opportunities

These themes continue to shape portfolio construction, with opportunities emerging across both global growth businesses and companies exposed to a gradual improvement in domestic conditions.

Electrification remains one area where we continue to see attractive long-term potential. CATL is a good example. The company has established itself as the world's largest battery manufacturer and continues to strengthen its competitive position through technology, manufacturing scale and continued investment in innovation. While electric vehicles remain an important source of demand, we also see growing opportunities in energy storage, which is becoming increasingly important as electricity demand rises, and renewable generation expands. Looking further ahead, electrification is expected to extend across commercial vehicles, industrial equipment and robotics, providing multiple drivers of future growth beyond the passenger vehicle market alone.

Artificial intelligence is another area that deserves close attention. Much of the recent discussion has centred on large language models, but we believe robotics will become an increasingly important part of the conversation over the coming years. China is well positioned across several parts of the value chain, from manufacturing and supply chains to AI model development and real-world data collection training. As more companies begin deploying humanoid robots within industrial settings, this is an area we expect investors to follow much more closely. While the commercial opportunity is still developing, we believe China's existing strengths provide a solid foundation for future growth.

Alongside these long-term growth opportunities, we also continue to find attractive businesses in areas where market sentiment remains weak. China Resources Land illustrates this well. Although the property sector has experienced a prolonged downturn, the company has continued to gain market share as weaker developers have exited the industry. At the same time, its investment property portfolio has continued to deliver steady growth, providing a resilient source of recurring income through the cycle. In our view, the market often focuses on the challenges facing the development business while overlooking the quality of the investment property portfolio. We are also encouraged by the continued development of China's Real Estate Investment Trust (REIT) market, which provides an additional mechanism for recycling assets and improving capital efficiency over time. Together, these characteristics make China Resources Land a good example of the type of business we continue to find attractive, even in parts of the market where sentiment remains subdued.

The road ahead

Looking ahead, our outlook continues to be shaped by what we are seeing beneath the surface of the market.

There are encouraging signs that investment is beginning to pick up, particularly in AI related industries, while household balance sheets remain healthy and the property market appears to be moving towards a better balance between supply and demand. More importantly, we continue to see Chinese companies investing in innovation, strengthening their competitive positions and competing successfully in an increasingly global industrial landscape.

For us, those company fundamentals remain the most important part of the investment case. Combined with attractive valuations, they provide a strong foundation for identifying businesses that can continue to compound earnings over the long term. While the headlines are likely to remain focused on macroeconomic and geopolitical developments, we believe the most compelling opportunities continue to emerge from the quality and competitiveness of the companies themselves.