Will China's AI boom survive escalating US trade tensions?

Strong start dampened by trade tensions

Chinese equities experienced a remarkable beginning to 2025, with the Hang Seng Index delivering impressive 15.4% returns in local currency terms. This surge ranked third globally behind gold and the DAX index among major asset classes.

The initial momentum stemmed from DeepSeek's launch of a low-cost AI model, which sparked investor enthusiasm about China's technological capabilities. Additionally, Beijing introduced updated consumption stimulus programmes alongside a more supportive stance towards private sector growth.

However, this positive trajectory faced headwinds as US-China trade relations deteriorated. The US implemented blanket tariffs on Chinese goods, raising rates from 10% in February to a peak of 145% in April before temporarily reducing them to 30% in May.

The combination of external trade pressures and persistent domestic challenges including consumer confidence issues, property market crisis, and demographic concerns has created a more cautious market environment.

Figure 1: Performance of major asset classes

Technology sectors lead year-to-date gains

'New economy' sectors dominated market performance throughout the early months of 2025. Information technology, healthcare, consumer discretionary, and communication services delivered returns ranging from 20% to 36% year-to-date.

Major technology companies including Tencent, Alibaba, and Xiaomi emerged as the top contributors to index performance. These firms continue demonstrating that rapid AI development will support their ambitious growth targets and market expansion plans.

The materials sector also benefited from surging gold prices, which boosted returns for companies operating in precious metals and mining operations. This performance reflects broader global safe-haven demand.

Conversely, the energy sector faced significant pressure as oil prices declined throughout the year. CNOOC ranked among the largest detractors from index performance, while Meituan and JD also contributed negatively amid intensifying competition in food delivery services.

Figure 2: Hang Seng Index sector performance

Table 1: Year-to-date top (left) and bottom (right) contributors to Hang Seng Index

Recent quarter shows mixed performance trends

The picture looks rather different when examining quarter-to-date performance. As investors await clear direction on trade policies and further central stimulus programmes, the Hang Seng Index and Hang Seng China Enterprises Index have traded sideways in the second quarter.

Sector performances have been widely dispersed during this period, driven primarily by individual corporate developments rather than broader market themes. This shift highlights how company-specific factors are becoming increasingly important for stock selection.

Strong financial results in the first quarter catalysed NetEase's share price to soar. The company's robust earnings provided a stark contrast to broader market uncertainty. Meanwhile, improving prospects for the initial public offering (IPO) market in Hong Kong emerged as a key reason behind HKEX's rally. Alibaba faced headwinds from an earnings miss and challenges amid rising US-China tensions, making it the worst contributor this quarter.

Table 2: Quarter-to-date top (left) and bottom (right) contributors to Hang Seng Index

Policy support aims for 5% growth target

Beijing has pledged substantial policy support to help the Chinese economy achieve its 5% growth target for 2025. The latest monetary easing measures included reductions in policy rates and reserve requirement ratios.

Specialised lending facilities were introduced to support key sectors including technology and real estate. These targeted measures aim to address specific challenges facing different industries while maintaining overall economic stability.

However, these policies primarily focus on injecting liquidity into the financial system rather than addressing fundamental issues of depleted credit demand. The Chinese economy has remained in deflationary territory since February based on year-on-year consumer price comparisons.

Markets generally expect additional stimulus measures, including fiscal policies, to help China navigate the dual challenges of domestic consumption weakness and external trade uncertainty. The effectiveness of these measures will be crucial for sustaining market momentum.

Trade negotiations create market volatility

The temporary reduction in tariffs following the Geneva meeting has provided short-term relief for equity markets. However, escalating tensions continue as the US revoked Chinese student visas and tightened restrictions on AI products.

Manufacturing data reveals the impact of deteriorating trade conditions, with the Caixin Manufacturing PMI falling to 48.3 in May -- the lowest reading since September 2022. This contraction reflects declining supply and demand driven by weaker export orders, leading to further shrinking of the labour force.

Global trade policies will significantly influence China's economy over the medium to long term, given that approximately one-third of GDP growth traditionally comes from net exports. The White House said President Trump and President Xi will speak over the phone this week, with the outcome of these ongoing negotiations set to determine near-term market sentiment. Meanwhile, the Hang Seng Index is likely to trade in range between 22,500 and 24,000.

Hong Kong IPO market shows revival signs

The Hong Kong stock market has experienced a notable pickup in new listing activities throughout 2025. Improved liquidity and performance in Chinese equity markets have been key drivers of this renewed interest.

US-China tensions have also acted as a catalyst, with some Chinese companies choosing Hong Kong listings over overseas options to mitigate regulatory and delisting risks. This trend reflects broader strategic considerations about market access and regulatory stability.

Following blockbuster listings from CATL and Hengrui Pharma, funds raised through IPOs on the main board reached HK$72 billion through May - the highest for this period since 2021. This represents a significant recovery in market confidence. Technology firm Will Semiconductor and fast-fashion retailer Shein are among companies considering Hong Kong listings later this year. These potential additions could further provide investment opportunities in new economy sectors.

Outlook for Chinese markets

Chinese markets face a complex landscape of opportunities and challenges as 2025 progresses. While the early-year surge demonstrated the potential for significant gains driven by AI developments and policy support, recent sideways trading reflects growing uncertainty about trade relations and domestic economic conditions.

The upcoming phone call between President Trump and President Xi could provide crucial direction for market sentiment, potentially determining whether the current trading range breaks higher or lower. Investors should monitor both geopolitical developments and domestic policy responses, as Beijing's ability to stimulate growth while managing trade tensions will be key to sustained market performance.

Despite near-term volatility, the revival in Hong Kong's IPO market and continued investment in technology sectors suggest underlying strengths that could support longer-term growth once trade uncertainties are resolved.