By Reshma Kapadia

Whether China's economy and stock market score another surprisingly strong year in 2026 depends in large part on how well things go in the U.S.

In 2025, the MSCI China exchange-traded fund has soared 29%, compared with 18% for the S&P 500. The Chinese economy rode out U.S. tariffs more easily than expected, and Beijing emerged from trade negotiations showing it has a strong hand to play against Washington.

And fund managers see a decent set-up for Chinese stocks next year. The enthusiasm sparked by the DeepSeek artificial-intelligence model continues to draw investors to China's "new economy:" AI, biotech, robotics, semiconductors, and clean tech, partly because they believe that becoming more self-reliant in tech remains a priority for Chinese leader Xi Jinping.

The October détente between Xi and President Donald Trump, and plans for them to meet several times in 2026, have raised hope that the countries can avoid a major worsening of friction while the leaders focus on domestic challenges.

China has an ample supply of problems. Beyond the dynamism in the "new economy," economists are focused on a struggling "old economy" that still accounts for 80% of gross domestic product. Property prices are still declining four years into a real estate slump, and investment and sales have fallen by double digits from a year earlier in recent months.

Retail sales grew 1.3% in November 1.3%, the slowest pace since 2022. A weak job market and a loss of household wealth resulting from the slide in property prices have made people reluctant to tap the additional $11 trillion in savings built up in recent years.

Investment, the lifeblood of economic growth, logged the worst decline in decades in recent months. Spending on fixed assets fell by 2.6% compared with a year earlier from January through November, marking the worst contraction in decades.

Companies aren't spending for a variety of reasons. According to Charlene Chu, senior analyst at Autonomous Research, they are holding back because of weak demand, the result of tariffs and supply-chain shifts, while deflationary pressure has dented their profit margins in recent years. A recent move by Beijing to tackle excess capacity and competition in certain areas is an additional problem, she says.

All that sounds like a reason for the government to step in with aid for the economy, but stronger-than-expected growth in the first half of the year is making the overall expansion look stronger than it otherwise would. Back then, U.S. companies were snapping up Chinese goods as they rushed to get ahead of the Trump administration's tariffs.

Vivian Lin Thurston, a manager for William Blair's Emerging Markets Growth fund, doesn't expect much stimulus in 2026, assuming exports hold up, gains in tech stocks continue, and the companies' plans for spending remain robust. She sees further gains for new-economy companies, arguing that rising earnings mean valuations will remain attractive even after the stocks' surge this year.

But how things play out depends in part on the outlook for global artificial-intelligence spending, and if the AI-stock bubble bursts in the U.S. A pullback in U.S. AI stocks would hit Chinese tech as well, Thurston says. Another potential spoiler: If the Federal Reserve keeps interest rates higher than expected, it could take momentum out of riskier assets including Chinese stocks, she adds.

On the positive side is that Beijing itself is a buyer of Chinese stocks. The so-called national team buys exchange-traded funds, and insurers are encouraged to increase their holdings of equities.

The 202 outlook for the world's second largest economy is less favorable. Many analysts expect middling growth, at best, because pre-tariff buying won't offer the boost to sales it did this year. And exports clearly matter more than they did in the past.

Five years before the Covid-19 pandemic, net exports accounted for an average 1% of China's GDP growth, while consumption powered 64%. In the last five years, net exports contributed 16% while consumption was less than half, according to the China-focused research firm Sinology.

For China's economy to muddle along, Chu says, the U.S. economy needs to do well and keep buying Chinese goods, even if they are no longer coming via Vietnam or Malaysia. Despite the U.S. tariffs, China's trade surplus hit a record $1 trillion in the first 11 months of the year as it increased sales to the rest of the world.

Beijing appears to recognize that the economy can't rely only on exports or investment. A collection of commentaries by Xi Jinping, published in December in Qiushi, a magazine closely read by policymakers, sparked optimism the government could be ready to act. "Expanding domestic demand is a strategic choice" was the title.

Rory Green, head of China research at TS Lombard, sees consumption as a potential national security issue. He argues that a minimum level of growth is critical to social stability, as well as Beijing's power and ambitions in tech.

The commentaries, he says, signal that Xi may prioritize boosting domestic demand in the way he pushed technology self reliance in 2012. That could help Beijing deal with calls from the U.S., European Union, and even the International Monetary Fund to rely less on exports and more on its own domestic demand, says Brendan Ahern, chief investment officer at KraneShares, a China-focused asset manager.

Any shift will take time. For now, analysts expect smaller efforts, like free kindergarten and the subsidies Beijing has rolled out for births. Efforts to develop domestic travel, sports, and entertainment to encourage older Chinese to spend their ample savings are another part of the picture.

Investors tiptoeing back into Chinese stocks may want to consider companies that would benefit both from the rise of AI and a potential effort by Beijing to boost consumption. The internet companies Alibaba Group, Tencent and Baidu, as well as e-commerce companies like JD.com and PDD, fit the bill.

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.

(END) Dow Jones Newswires

December 27, 2025 01:30 ET (06:30 GMT)

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