By Reshma Kapadia

As China enters the Year of the Snake, investors are hoping the economy and Chinese stock market can shed some of their recent bad energy. Chinese AI start-up DeepSeek's success, the Trump administration's decision to review China trade policy rather than start with high tariffs, and expectations for Beijing to pump up economic stimulus lay the groundwork for some optimism -- at least for the first couple of months. Yet longer term, there is plenty of reason for concern, including uncertainty about how the trade rivalry between the countries will play out.

The near-term outlook for the Chinese market will be determined by whether -- and how -- President Donald Trump follows through on his threats of levying tariffs of as high as 60% on Chinese imports. Equally important is how Beijing follows through on its vows to stabilize its economy amid a rout in its property market and flagging consumer and business confidence.

The iShares MSCI China exchange-traded fund rose 31% over the past year to $49.58, but uncertainty around tariffs and a lack of more aggressive follow-through on stimulus have sapped momentum in recent months. Analysts are hoping Trump's proclivity for deal-making could hold off tariffs, adding to the potential for Beijing's stimulus plans to bring it back.

The Economic Outlook

China's economy continues to sputter but analysts see glimpses of momentum after incremental stimulus measures rolled out so far. Money supply is improving and retail sales are showing signs of picking up.

Most economists expect Beijing to stick with its target for growth of about 5%, though most see the number as ambitious. Rory Green, TS Lombard's head of China research, expects a 4.7% increase in gross domestic product this year. While Green expects the export growth that has been a bright spot for the economy to deteriorate amid tariffs, he expects some pickup in consumer and business spending if stimulus takes hold.

But trouble persists. On Monday, China Vanke, one of the country's biggest and most conservative developers, reshuffled its top executives and warned of a 45 billion yuan ($6.2 billion) net loss. While the government appears to have reduced the odds of a default by taking control of Vanke, Gavekal analysts said in a note to clients that continued struggles at the company would deal a further blow to consumers' faith in developers and the tentative recovery seen in property sales in some markets.

China's structural challenges with debt and the fallout from the property bubble bursting will continue to be a long-term drag. And growth could slow in the second half of the year, especially if Trump goes ahead with the 60% tariffs he has threatened to impose on Chinese imports.

Uncertainty Over Trade

Chinese markets are already anticipating an increase in tariffs of about 15% from current levels. And Green says the economy could probably weather the damage if the rate gradually rose by as much as 35%. A rate of 60% would likely reduce forecasts for GDP growth by at least a percentage point, depending on what is targeted. Currently, tariffs on many Chinese imports range from 7.5% to 25%.

Complicating the outlook for investors is mixed messaging from the Trump administration. The president has talked up his close relationship with Chinese leader Xi Jinping and talked about China potentially helping the U.S. with priorities such as ending Russia's war in Ukraine. But Trump has also threatened tariffs repeatedly and set in motion a reassessment of the Phase One China trade deal. The review concludes on April 1.

Separately, the White House on Friday said it would impose 10% tariffs on China related to the flow of fentanyl into the U.S.

While Andy Rothman, head of the China-focused research firm Sinology, says the purpose of Trump's tariff threats isn't clear, he sees the decision to reassess the China trade situation, rather than start with tariffs, as opening the door to a potential deal. Many in the incoming administration are well aware of the trade dynamics, especially as Jamieson Greer, the nominee for U.S. Trade Representative, helped strike the Phase One trade deal.

What Beijing Could Do

On the ground in China, Rothman says, Xi could generate his own momentum in rebuilding confidence after rattling entrepreneurs, consumers, and comsuners with crackdowns and policy uncertainty for the internet sector, property, and online videogames. "The government has made a lot of mistakes, which led to the slowdown in growth and collapse in consumer and entrepreneur confidence," Rothman says.

"We have seen some reversal [in policies] and stabilization but Xi needs to take to the next level and be out front himself to deliver the message."

To gauge whether Beijing's messaging works, Rothman is monitoring household bank deposits, which have grown 90% in dollar terms since 2020, representing $10 trillion in additional savings. That is on the order of what was seen in the U.S. post-Covid, but unlike American consumers, Chinese households have been unwilling to spend the money.

For many investors, the key factor is stimulus -- how much Beijing delivers and how much more it provides if the U.S. starts a trade war. Even if there is a tentative deal, most analysts expect some tariffs on China over the longer term. "The die seems to be cast in terms of policy: We will get more fiscal support, but centered on investment, and some modest cuts to interest rates," says Neil Shearing, chief economist at Capital Economics. "That will help drive a further pickup in growth over the first half of the year, but I expect growth to slow later on as the effects of policy support fade."

For now, Green expects fiscal stimulus as big as 9% of gross domestic product: sizable but smaller than what China tapped in 2015 to 2016 and after the 2008 financial crisis. The expectation is that the first wave of moves will be unveiled at the National People's Congress in early March, though policymakers may save some firepower for later, given the April 1 date for the U.S. trade-policy review.

What It Means for Markets

All this uncertainty could play in the favor of Chinese stocks up to the March meeting. The hope of stimulus and a more gradual approach to tariffs could be enough to attract contrarians looking for bargains, especially because China's market already reflects a lot of bad news.

Most fund managers are sticking to consumer-oriented companies, such as internet companies Pinduoduo, Alibaba Group Holding, and Tencent Holdings. Travel and other consumer-oriented companies that will benefit from stimulus and are unlikely to get caught in the tariff crossfire are attracting attention as well . Green says commodities such as iron ore and copper could gain if the stimulus effort relies on investment and infrastructure spending.

Still, recent history isn't in the market's favor. The longer-term challenges remain, and investors have been burned before.

Write to Reshma Kapadia at reshma.kapadia@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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February 01, 2025 02:00 ET (07:00 GMT)

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