China is heading into 2026 with an economy that still looks fragile on the surface—slowing growth, weak consumption, lingering deflation and a property market yet to stabilise. Paradoxically, these very challenges are becoming supportive for equities, as investors increasingly view them as catalysts for renewed stock-market gains rather than reasons for pessimism.

At the core of this optimism is liquidity rotation. Persistently low inflation is pushing bond yields lower, making fixed income unattractive for domestic savers. At the same time, China’s equity dividend yields are meaningfully higher than bond yields, creating a strong incentive to shift capital into stocks. AAA-rated renminbi corporate bonds yield around 1.7%, while equities in the CSI 300 Index are expected to offer dividend yields closer to 2.7% in 2026—one of the widest gaps seen in decades.

This dynamic is reinforced by household balance sheets. Chinese households hold an estimated US$41 trillion in financial assets, yet only about 12% is allocated to equities, far below levels in developed markets such as the US. With property still under pressure and bond returns capped, equities are increasingly seen as the only major asset class capable of delivering real wealth creation. Even a modest rise in equity allocation could unleash trillions of dollars of new demand into the stock market.

Policy direction is another key support. Beijing appears intent on encouraging a shift toward an equity-driven “wealth effect” through capital-market reforms, state-backed stock purchases, and guidance for insurance and pension funds to increase equity exposure. These measures suggest sustained policy backing rather than one-off stimulus.

External factors add further momentum. A weakening US dollar—already softer in 2024 and 2025 and expected to decline further in 2026—reduces the appeal of US assets and encourages global investors to rotate into undervalued emerging markets. China, with improving earnings and reasonable valuations, stands to benefit disproportionately. Foreign inflows picked up strongly in 2025 and could accelerate further if the renminbi strengthens against the dollar.

Valuations remain supportive despite last year’s rally. The CSI 300 Index trades at around 16–17 times earnings, with analysts forecasting earnings growth of over 13% in 2026. Combined with rising dividend payouts, this supports the potential for double-digit annual returns over the medium term.

That said, risks remain. Geopolitical tensions could resurface, especially if US-China trade frictions intensify again. Domestically, high youth unemployment, demographic headwinds and local-government debt may constrain growth and limit policy flexibility. After strong gains, market corrections of 15–20% are also likely along the way.

Overall, however, the base case for China equities into 2026 is constructive. Structural shifts in domestic savings, continued policy support and potential foreign inflows amid a weaker US dollar create a favourable backdrop—provided there is no major trade shock or renewed deflation.

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