[Reuters Analysis] China stocks offer hedge against fading US exceptionalism: Taosha Wang

March 18 - U.S. equity markets are facing severe headwinds in early 2025, while Chinese equities rally, leaving global investors – structurally underweight China since 2021 – scrambling to adjust. This divergence underscores a critical question: Are Chinese stocks an effective hedge against fading U.S. exceptionalism?

U.S. equities have climbed relentlessly in recent years as China has languished in a bear market, prompting existential debates about the latter's "investability." In early 2025, the roles have reversed.

The benchmark U.S. S&P 500 index is down over 4.0% this year, while Hong Kong’s Hang Seng Index (HSI) - where many major Chinese companies are listed - tops global equity year-to-date (YTD) performance charts with a 19.6% gain as of March 14.

Chinese stocks historically have exhibited low correlation with U.S. markets: 0.49 versus 0.76 with Europe. So this year’s performance divergence is not extraordinary.

But the current dynamic is distinct because it is being driven by a dramatic shift in technological and macroeconomic trends.

ERODING U.S. TECH DOMINANCE

The technology sector has long been a cornerstone of earnings growth in the U.S., with artificial intelligence recently emerging as the latest crown jewel. However, China is catching up in the AI tech race.

Nasdaq’s trillion-dollar selloff following the unveiling of DeepSeek’s cost-effective R1 model likely marks a watershed moment.

The threat is not just competition from a cheaper, equally-capable Chinese alternative, but the rise of open-source AI frameworks, which offer a direct challenge to the proprietary models of dominant U.S firms like OpenAI.

This commoditization of AI models, and cutting-edge technology in general, erodes the "moats" that once justified sky-high valuations for U.S. tech giants, and raises questions about Silicon Valley's "spend-first" approach to AI investments.

China's tech sector, often seen as a fast follower, is now poised to leapfrog the U.S. in innovation.

Top Chinese AI apps now collectively boast 100 million daily active users (DAU). While still behind ChatGPT’s 150 million DAUs, these firms are closing the gap rapidly.

DeepSeek and its open source variants are also gaining a loyal customer base in the sciences, where researchers value transparency, logical rigour, and cost-efficiency.

If history is any guide, the next stage of AI development will focus on commercial applications. Chinese firms have a proven track record in commercialisation.

They have led the world in mobile payments, for example AliPay, and super apps like WeChat, which integrate messaging, payments, e-commerce, and social media.

There is little reason to doubt the ability of Chinese tech companies to replicate this success in the AI era.

DIVERGING MACRO TRAJECTORIES

While the U.S. economy remains resilient, with unemployment still low at 4.1%, fault lines are emerging.

Investor sentiment has been damaged by escalating trade tensions amid back-and-forth tariffs announcements, and policy whiplash from erratic Department of Government Efficiency (DOGE) headlines.

And concerns about the U.S.’s high fiscal deficit – 7% of GDP – and its unwieldy debt-to-GDP ratio of 122%, linger in the background.

China, conversely, has signalled a tentative rebound after years of stagnation. Deflationary pressures linger – the consumer price index (CPI) was at -0.7% year-on-year in February – but the government’s stimulus efforts are gaining momentum.

Plans to expand the fiscal deficit by one percentage point to 4% of GDP this year should channel over 1 trillion yuan ($140 billion) into the economy, boosting domestic consumption, just as the property market appears set to stabilise.

Meanwhile, President Xi Jinping’s recent high-profile meetings with tech leaders indicate a clear commitment to business friendliness, which has helped to revive corporate "animal spirits".

DECLINING DOLLAR STRENGTH

The U.S. dollar’s reserve currency status has historically enabled U.S. policymakers to sustain large deficits without triggering severe currency depreciation. Robust U.S. growth has driven asset appreciation and reinforced dollar strength.

Yet the dollar’s 4.4% decline this year, as measured by the DXY index, has altered the calculus, especially as this weakness has corresponded with rising economic and geopolitical tensions, calling into question the currency’s safe haven status.

This weaker dollar enhances returns for non-U.S. assets, particularly in emerging markets. The yuan has risen only a modest 1.3% against the dollar this year and thus may have more room to go.

Crucially, Chinese equities are less vulnerable to FX swings than stocks in many other countries, with over 80% of MSCI China firms’ revenue domestically-sourced.

China's equity market is also home to global industry leaders like automaker BYD that have significant structural advantages: export prices for its vehicles are two to three times domestic levels, yet remain competitive globally, rendering marginal exchange rate shifts largely inconsequential.

STRUCTURAL HEDGE

Chinese equities may represent a structural hedge against waning U.S. exceptionalism, transcending cyclical rebounds, given today’s massive geopolitical and technological shifts – from U.S. political volatility to AI democratisation.

But this is not a zero-sum game. Rather, it reflects a multipolar world where U.S. exceptionalism is no longer the default. The ultimate hedge may lie not in betting against America, but in recognising its primacy as relative, not absolute.

(The views expressed here are those of Taosha Wang, a portfolio manager and creator of the "Thematically Thinking" newsletter at Fidelity International.)

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