China’s innovation strategy has become increasingly centralised.

With its rapid advancements in critical technologies, today, China is a formidable competitor to the developed West for global technology leadership. Innovation can take many forms, including process innovation in which China excels to leveraging its large and dynamic manufacturing base.

“However, this is not enough. Technological progress also hinges on a nation’s ability to develop and spread innovation, to boost aggregate productivity and potential growth. On this, China’s innovation strategy has become increasingly centralised, with the government favouring specific sectors and systematically cracking down on others,” noted Claire Huang, Senior EM Macro Strategist, at the Amundi Investment Institute.

“A dynamic private sector and decentralised approach are essential for new technologies to spread and become accessible, fostering progress. In this respect, the environment for Chinese companies and institutions to innovate has deteriorated recently.”

Today, the United States and its allies still hold significant advantages in capital markets and innovation ecosystems, while Chinese regulators crack down on the financial sector.

“For China to sustain its technological rise, it must prioritise final-demand innovation. While top-down, state-driven approaches have been effective in certain areas, they may not be sufficient to boost long-term growth. If China’s policies continue to stifle these market forces, its technological rise may plateau. China’s future success will depend on whether it can balance its top-down, state-driven approach with the bottom-up forces of consumer demand and commercialisation,” she noted in the attached paper ‘China in the race to technological leadership’.

“Ultimately, the key to long-term technological leadership lies in a nation’s ability to commercialise and spread its innovations. As the Soviet Union’s experience shows, technological discovery alone is insufficient for sustained growth.”

The United States hosts the world’s most efficient capital market that incubates pioneering innovators (from 0 to 1). Its single and unified market provides a fertile ground for enterprises to expand their scale with unparalleled ease.

China has developed the world’s largest and most cost-efficient manufacturing sector. With its intricate and highly developed supply chains, it empowers companies to innovate through execution and scaling (from 1 to 100). Numerous Chinese manufacturers, with their ‘can-do’ spirit, produce goods that others often find economically unfeasible to replicate.

“Investing in Chinese tech leaders via selecting ‘scaling champions’ is a viable approach, considering the high barriers to entry created by their cost efficiency.

“Although corporate China exhibits competitiveness across multiple domains, geopolitical tensions and deflationary pressures loom large, potentially undermining its profitability and long-term growth prospects. A strategic shift towards stimulating consumer demand is crucial to fighting deflation and sustaining China’s technological ascendancy. A failure to escape deflation may weaken the investment case for China tech,” added Huang.

Asia commands the lion’s share in the production of sophisticated information technology hardware. “Attempting to relocate these established supply chains to the United States would almost certainly result in diminished profit margins, reduced yield rates and escalated costs for downstream consumers. Companies with higher pricing power and gross margins are likely to better absorb the costs of reshoring, thus mitigating the risks associated with America First policies.”

In this respect, it is worth mentioning the very active subsidies programme from the Chinese government, at every level of an industry that the government considers as strategic (e.g., within the semiconductor industry, subsidies are given to the upstream companies such as chemical or semi-equipment providers, to midstream fabs and subsidies are given to the downstream buyers of the end products).

“This process around subsidies at every level to develop an ecosystem from scratch at an unprecedented speed and scale is now proven, which China’s policymakers have learned from their previous successful experience in low/mid-end manufacturing.”

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What are the the risks and rewards of investing in China?

The outcome of US-China trade talks this past weekend exceeded expectations according to Amundi, Europe’s largest asset manager.

As a result, Amundi has upgraded its forecast for China GDP growth to 4.3% in 2025 and 3.9% in 2026, from 3.9% and 3.7%, respectively.  However, this upgrade does not fully restore the 4.4% growth forecast Amundi had at the start of 2025.

Claire Huang, Senior Emerging Markets Macro Strategist, Amundi Investment Institute noted, “While the tightening in global financial conditions was brief and has since normalised, the uncertainty surrounding trade policy remains elevated, continuing to weigh on private sector confidence and is likely to have lasting effects.”

The outcome of the weekend talks significantly reduces the probability China will initiate additional fiscal stimulus in Q3.

“Amundi no longer expects major measures in the very near term as the 90-days pause buys enough time through mid-August.

“Amundi maintains its forecasts that PBoC will proceed with two additional 10bp rate cuts in July and September. As April CPI/PPI shows, deflationary pressures have been persistent, and further monetary easing is much needed regardless of the results of the negotiations,” she added.

“Onshore A-share equity market does not fully price in this outcome, but further upside will be limited since valuation has nearly returned to levels pre-Liberation Day.

“Amundi expects RMB to range bound. Near term the outcome is positive for RMB to rally. However, the outcome is also positive for the US dollar, which could reverse some of its sell-off in past month.” 

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According to Amundi, Europe’s largest investment manager, this robust performance is unlikely to be replicated with the same strength in 2024, but the outlook for the market remains favourable.

Eric Mijot, Head of Global Equity Strategy, and Claire Huang, Senior EM Macro Strategist, at the Amundi Investment Institute note that the arguments supporting a positive stance still seem credible.

They list the following reasons:

1. Firstly, earnings growth in Japan’s market remains attractive.
   It was higher than that of the US market in 2022 and 2023, and was less volatile than that of Europe. For 2024, the Ibes consensus forecast at +7.6% is less than that for the MSCI ACWI (+10%), but unlike for the other markets (notably the Pacific excluding Japan), its forecast for the TOPIX is regularly revised upwards. The 6.9% average fall in the Yen versus the US Dollar in 2023 was a positive factor behind market performance, which will be difficult to replicate in 2024 and justifies lower earnings growth than in 2023. However, domestic economic growth will remain buoyant. It should stabilise around its current rate (+1.6% in 2024 compared to +1.8% in 2023), while global growth should slow further (+2.4% in 2024 compared to +3.1% in 2023).
2. Secondly, the reforms introduced by the TSE (Tokyo Stock Exchange) in March 2023 will continue to produce positive effects in 2024. The aim is to encourage companies with a P/BV (price-to-book ratio) of less than 1x (43% of companies had a P/BV lower than 1x versus 5% in the US and 24% in the EU, according to TSE’s calculation) to implement measures to improve this by March 2025. In other words, returns on equity should increase and not only through buybacks.

In mid-January 2024, the TSE published the names of the 660 companies that have already taken action, which should encourage them to continue and others to follow.

3. Lastly, the Japanese market should continue its rerating. By definition, the TSE reform works in favour of market rerating. The end of the deflationary environment, which has long penalised the equilibrium levels of Japanese P/Es, has been a key underlying factor in performance in 2023 (77% contribution to the total return performance of the MSCI Japan). The market’s P/E has now returned to its average of the last 12 years, at around 14x 12-month forward earnings. Wage negotiations in the spring should lead to wage rises for the second year running and that should be sufficient to confirm a scenario of an end to deflation and confirm the market’s continued rerating above its average of recent years.

“The risks to these positive arguments are mostly linked to the Yen. A strong comeback by the Yen, should global equity volatility increase sufficiently in 2024 to encourage the unwinding of carry trades, would weigh on the performance of Japan’s equities in local currency. It would penalise profits and, everything else being equal, slow the process of increasing inflation, weighing on valuations at the same time. For international equity investors, not hedging the Yen in 2024 could thus be an attractive option,” notes Huang and Mijot.

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