China: A trot, not a gallop — so far

When I wrote in February that the Year of the Fire Horse felt different, the emphasis was on transition rather than acceleration. Now, with the first quarter of 2026 behind us, that framing still feels right but with an important caveat. China hasn’t stumbled, but it also hasn’t broken into a run. So far, this year has been a trot, not a gallop.

The regional context matters. The Asia ex‑Japan region delivered another quarter of extreme dispersion. Technology‑heavy markets such as South Korea and Taiwan surged early in the year, buoyed by artificial intelligence (AI)‑related demand and a weaker US dollar, before giving back some gains in March as the Middle East conflict triggered a global risk‑off move. China, by contrast, lagged throughout the quarter, underperforming regional peers and leaving investors once again asking why it has been left behind — and whether its performance reflects an underlying reality.

A diversified energy mix

Geopolitics is part of the answer, but not in the way many fear. The idea that China would be one of the biggest casualties of the Middle East conflict has proven too simplistic. China is less exposed to energy supply disruptions, importing approximately 40% of its crude via the Strait of Hormuz — considerably less than its regional peers. Its energy mix is also more diversified, with renewables now accounting for about half of electricity generation. Strategic oil reserves, estimated at roughly four months of seaborne imports, provide an additional buffer, even if Beijing is understandably reluctant to draw on them unless conditions deteriorate materially.

That said, insulation is different from immunity. Higher oil prices still feed into costs, and the longer the conflict drags on, the more those pressures accumulate. March offered a notable signal: China’s Producer Price Index — which measures the average change over time in the selling prices that domestic producers receive for their output — turned positive for the first time in more than three years. This is not benign inflation; rising input costs risk squeezing margins that are only just recovering, but it does matter psychologically. After years of deflation, it helps re‑anchor expectations and reduces the risk of a self‑reinforcing downward price mindset.

Exports remain another source of both support and vulnerability. Last year’s trade surplus accounted for roughly a third of China’s economic growth and sustaining that contribution will be harder if global consumers are squeezed by higher energy and food prices. Yet the composition of exports continues to evolve. Electric vehicles (EVs), batteries, and solar equipment — areas where China accounts for about 70% of global capacity — are becoming increasingly important globally, and the Middle East crisis is likely to accelerate the push toward energy security across Southeast Asia and beyond.

China has a clear stake in open trade routes, but it may also be well positioned to supply the next wave of global investment.

Consumer confidence

Domestically, China’s economy has started the year reasonably well. First‑quarter GDP growth came in at the upper end of the official target range. Manufacturing and exports are holding up. What has not yet turned decisively is property or consumer confidence. There are tentative signs of stabilisation, for example an increase in activity in the larger cities; improving Hong Kong retail rents; and less-aggressive price competition — but it may be premature to call a bottom.

Policy remains pragmatic rather than forceful. If exports weaken, stimulus will likely increase; if they hold, less so. A decisive move might be to restore household balance sheets via property ownership. It would change sentiment quickly, but that step has not yet been taken.

Short-term narratives

Markets, however, are not trading purely on macroeconomic fundamentals. Part of China’s underperformance reflects how its domestic equity market now functions. Long‑only fundamentals-led investors account for a much smaller share of overall trading activity than in the past. The market is now dominated by hedge funds, retail traders and Stock Connect flows. It has meant stock markets have become more momentum‑driven and sensitive to short‑term earnings narratives.

As a result, capital has naturally gravitated toward what was working earlier in the year: AI‑linked names in South Korea and Taiwan, and beneficiaries of the commodities boom. At the same time, China — facing slower growth from a high base and rising costs — has been left behind. Overall, it looks less like a judgement on the country’s long‑term prospects and more a function of liquidity, positioning, and narrow time horizons.

That dynamic has been reinforced by familiar sector‑specific concerns. Large internet and consumer platforms continue to face intense competition, lingering deflationary pressures and worries about losing market share.

Subdued earnings growth

Near‑term earnings growth remains subdued, and in a market dominated by short‑term capital, conviction has been slow to rebuild. Yet none of this negates the longer‑term transition underway. China’s shift away from property toward technology, advanced manufacturing, renewables and automation remains intact. It is firmly established as the world’s number two player in AI and is a leader in green energy and robotics.

If anything, this backdrop strengthens the case for selectivity. Returns are unlikely to be broad‑based, and dispersion, both in operating performance and share prices, is likely to remain high. In markets increasingly driven by short‑term flows, patient capital focused on fundamentals may need to wait, but it can be rewarded for doing so. China may not be galloping, but it is still moving forward and we believe that steady pace may yet prove more rewarding than the current market situation suggests.