China markets to outperform Wall Street as U.S. exceptionalism pauses

A rally in Chinese stocks since the start of the year is prompting investors to predict that mainland shares will outperform their American peers in a sign that attractive valuations are trumping the idea of “American exceptionalism.”

Last week, the S&P 500 slipped into correction territory for the first time since 2023. In contrast, the MSCI China index has gained 19% since the start of the year, to Mar. 9, according to Goldman Sachs, marking its best start to a year in history.

The contrasting fortunes mark a swift turnaround from just a few months ago when many investors believed the U.S. was uniquely positioned to weather economic and political storms buffeting other countries. Chinese stocks were also languishing due to regulatory worries and concerns over the health of the Chinese economy.

A lot has changed since.

U.S. President Donald Trump’s tariffs policy has fanned speculation of an economic slowdown in the world’s largest economy.

Meanwhile, in China, optimism around the country’s artificial intelligence capabilities has intensified since the introduction of DeepSeek’s R1 model earlier this year.

“The U.S. has had a good period, and that’s coming to an end because Trump’s policies are very anti-economy. China has had a very bad period, but it looks as if it’s starting to recover,” Richard Harris, CEO of Port Shelter Investment Management, told CNBC.

“I call it the great pivot. Obviously, over the last 5 to 7 years, U.S. markets have been dominant. The Magnificent Seven have gone to the moon … [But] it seems difficult to see that there’s much more to go,” Harris said.

The tech-heavy Nasdaq Composite is also in correction territory, dragged by a selloff in Magnificent Seven shares, driven by recession concerns and trade war fears. The Magnificent Seven comprises Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.

“The U.S. stock market capitalization, relative to world stock market capitalization, made an all-time peak at the end of last year amidst the then prevailing talk of ‘American exceptionalism,'” said Chris Wood, global head of equity strategy at Jefferies Hong Kong Global.

In the same vein, Eastspring Investments’ Asia equity portfolio specialist Ken Wong believes that the American exceptionalism trade ended earlier this year. Expected fiscal tightening and Trump’s tariff war are expected to slow U.S. economic growth to below 2% this year, Wong said, compared to consensus estimates of 2.2%.

The U.S. saw real GDP growth of 2.8% in 2024 compared to 2023. The U.S. debt and deficit situation became more severe during President Donald Trump’s first month in office, and since then, he has prioritized addressing the government’s fiscal issues.

Stagflation is a key risk in the U.S. as the tariff war could depress economic activity to the point of recession while simultaneously increasing inflation, Wong added.

That could mean the slump in U.S. equities may not be done.

“We see the selloff in U.S. equities as having further to go,” Deutsche Bank wrote in a note published over the weekend. “With trade policy uncertainty likely to continue to weigh, at least until April 2, we expect positioning to continue to unwind.”

“A move to the bottom of the positioning band which is where it went to in the last trade war, would take the S&P 500 down to 5,250,” said the bank’s chief strategist Binky Chadha. That will mark a more than 7% slide from Monday’s close of 5,675.12.

On the other hand, China tech shares have been on a tear since DeepSeek’s breakthrough. The Chinese government has also actively signaled its support for its technology sector, with plans to increase funding in the cards. 

The Hang Seng Tech Index, which tracks some of the largest Chinese technology companies listed in Hong Kong, has risen over 30% since the start of the year, according to data from LSEG.

“Investors should be looking to sell rallies in the U.S. and buy corrections in Europe and China where there is the most evidence of improving fundamentals,” Wood told CNBC.

To be sure, the sheer pace of China’s rally could portend a correction soon, according to analysts at Bank of America.

“Performance of the HSCEI/MSCI China in the past 17mths trended closely to the trajectory a decade ago, making us worry that we might be approaching some correction soon,” analysts at the Bank of America wrote in a report published on Monday.

The bank’s analysts believe that there are “fundamental similarities” between the current cycle and 10 years ago in terms of the country’s policy stimulus and reforms, economic re-balancing and technological breakthrough.

“I’m not worried so much about valuation. It’s important, but it’s not the 100% factor. What is more important at the moment, is that there’s much more momentum in the Chinese market,” Harris said, adding that China’s government stimulus has trickled into the economy and markets.

In a report released last week, Citi Research upgraded China to overweight, while downgrading U.S. equities to neutral because U.S. exceptionalism has paused after being overweight since October 2023, expecting more negative data prints from the country’s economy.

However, Citi maintained that its neutral outlook is a three—to six-month view, emphasizing that the U.S. will remain one of the leaders of AI, even if jointly with China.

“In the bigger picture, we doubt that the AI bubble is already fully played out,” the investment bank’s strategists led by Dirk Willer wrote.