Market Updates - China's Great Divergence

Introduction

China's economy this June presents two divergent narratives simultaneously. On one hand, demand-side weaknesses have persisted, most visibly in household consumption and the prolonged contraction in property and real estate investments. Data released on June 16th showed that retail sales fell in May for the first time since December 2022, dropping 0.6% year-on-year, while urban fixed-asset investment contracted 4.1% in the January-to-May period, steepening sharply from the 1.6% decline recorded through April. Real estate dragged hardest on investment, with inflows down 16.2% over the first five months of the year. However, on the other hand, a separate cluster of sectors is generating genuine momentum for the economy, partially offsetting the drag from consumption and the property market. Export growth continues to be driven by higher-value-added products such as EVs and lithium batteries, and demand for AI has surged to the point where semiconductor imports hit a record $135 billion in Q1 alone. Taken together, these divergent signals suggest that the headline growth figure is increasingly misleading as a summary of China's economic condition, as it integrates two narratives moving in opposite directions. What matters more, is the widening gap between the sectors still weighed down by the legacy of the property boom and the ones being actively reshaped by industrial policy, AI investment, and global supply chain realignment. 

Declining Housing Sector and Consumer Confidence

In 2020, guided by Xi Jinping’s principle that “houses are for living in, not for speculation”, Beijing introduced the "three red lines" rule. It set strict limits on developer debt, capping how much firms could borrow based on their financial health. Overleveraged property players were hence banned from taking on new debt. The policy’s aim was to cool an overheating property market and redirect credit to manufacturing and tech. However, in doing so, the policy starved the entire sector of the funding it relied on to function. Evergrande, the most indebted developer in the world, defaulted in December 2021 and was ordered into liquidation in January 2024. Other developers subsequently followed. Five years later, the damage is still apparent. According to Goldman Sachs, new home prices across China's 70 major cities have been falling since 2021, knocking roughly 2 percentage points off GDP growth in both 2024 and 2025.

The question right now is if the crisis is taking a turn for the better, and the answer is no. Prices are falling more slowly, but a slower decline is not recovery. S&P Global Ratings projects home sales to fall a further 10 to 14% in 2026 as unsold apartments continue to drag prices down. Furthermore, Fitch Ratings forecasts annual housing demand will average 800 million square metres through 2040, less than half the 1.6 billion sold at the 2021 peak. The era of booming construction is structurally over.

The damage from the property sector is widespread. Roughly 70% of household wealth is tied up in homes, so when home prices fall, consumer confidence and spending are crushed. The effect is visible throughout the nation; retail sales grew just 0.9% in December 2025, the weakest in three years, while household bank deposits have swelled to 163 trillion RMB in the first half of 2025, nearly double the level five years earlier. Money that once flowed from consumers to businesses is now sitting idle in savings accounts. Beijing has cut mortgage rates and lowered down payments to encourage spending, but cheaper loans do not tackle the core problem of confidence. Until the fear fades, most analysts expect an L shaped recovery.

Thriving Tech Sector

Yet China's weakness is not spread evenly. Property and household consumption remain under pressure, but capital has not disappeared. It has been redirected into the sectors Beijing treats as strategic: artificial intelligence, electric vehicles, semiconductors and advanced manufacturing. The investment data already shows the shift. Over the first four months of 2026, overall fixed asset investment fell 1.6% year on year, yet high technology industries grew 6.1%. Some categories ran far hotter still: aerospace equipment manufacturing up 17.9%, computer and office equipment up 13.9%, information services up 18.1%. What looks like a slowdown is partly a reallocation, with growth pulled away from property-led expansion and pushed towards a more policy directed industrial model.

Electric vehicles are the clearest case. China is no longer just a large domestic market for EVs; it now sits at the centre of global EV and battery production. In 2025 it accounted for roughly 70% of the world's electric car output and more than 80% of battery cell production, while dominating key inputs such as cathode and anode active materials. BYD shows what that looks like at the company level. Sales climbed from around 400,000 vehicles in 2020 to 4.6 million in 2025, enough to make it the sixth largest automaker in the world, and its exports from China rose 65% in the first five months of 2026. That is what gives the story reach beyond China's borders: Chinese firms are now fighting Japanese, Korean and European rivals for global share, not simply living off domestic subsidies and low prices.

AI and semiconductors follow a similar pattern, though a messier one. The global AI build-out has lifted demand for chips, servers, optical components and data processing equipment, all areas where China's manufacturing base still counts. Integrated circuit exports jumped sharply in May, and exports of automated data processing equipment rose strongly alongside them, carried by spending on global AI infrastructure. Yet the same month brought record semiconductor imports, a reminder that China still leans on foreign advanced chips and tools at the high end of the value chain. Here, strength and dependence sit side by side.

Conclusion

Overall, the divergences with China’s economy have revealed two structurally distinct trajectories which macro-level figures fail to capture. For investors, a macro-level bull-bear call on China has become hard to make with any conviction. Current figures have exerted pressure on Beijing to consider meaningful stimulus to stabilise household consumption, yet the structural momentum in AI and high-tech manufacturing continues to attract capital regardless of broader macro weaknesses. However, it is unlikely that advances in high-tech manufacturing industries would offset the country’s demand-side weaknesses. Momentum in capital-intensive, export oriented sectors does not directly address the underlying issues surrounding consumer confidence and spending - given that 70% of household wealth is tied up in homes, the declining housing sector has consequently eroded domestic consumption. Taken together, these dynamics have suggested a widening gap between China’s sectors, and therefore a sector-level assessment would be a more effective evaluation of the country’s economic condition. 

Sources: CNBC, Reuters, National Bureau of Statistics of China, ITIF, Global Property Guide and Yahoo Finance