So bad it’s good: why Chinese equities could shine in 2026

Article first published in The Business Times on 26 December 2025 here. 

Sometimes good things happen for all the wrong reasons, a paradox not uncommon in the topsy-turvy world of financial markets. Take China for example.

As the world’s second largest economy heads into 2026, its economy continues to flash warning signs with slowing growth, lingering disinflation, subdued consumption, and a property market still trying to find a floor. But far from signalling despair, these lukewarm conditions are increasingly being viewed by investors as catalysts for another leg higher in equities. How so?

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Rotating liquidity

It’s all a function of liquidity. Persistent low inflation is expected to drive bond yields even lower, leaving domestic savers with few alternatives for meaningful returns beyond stocks. At the same time, a softening US dollar – already down in 2025 and forecast by Lombard Odier to weaken even further in 2026 – could prompt USD-based investors to seek and explore growth and earnings in undervalued emerging markets. Together, these domestic and international rotations could mirror the dynamics that propelled Chinese stocks to strong gains in 2025, setting the stage for continued outperformance into 2026.

Driving equities higher is the negative difference between (lower) bond yields and (higher) equity dividend yields, a phenomenon in place since mid-2023. AAA-rated renminbi (RMB) corporate bonds now yield around 1.7 per cent while the CSI 300 Index is forecast in 2026 to offer investors a dividend yield of around 2.7 per cent, a delta wider even than the Global Financial Crisis or Covid-19 periods. This makes fixed income (deeply) unattractive for China’s vast pool of household savings, pushing capital toward equities.

Historical performance reinforces the point: over the past 15 years, RMB bonds have provided steady but low single-digit annual returns, rarely exceeding 10 per cent. In contrast, mainland indices such as the CSI 300 Index and MSCI China Index (plus the Hang Seng Index), have shown far greater volatility but also substantially higher compounded gains during up-cycles – often 20 to 30 per cent in strong years. Equities have been the superior asset class in a prolonged low-yield environment.

The bond-to-equity rotation is also underpinned by a structural reallocation of household wealth. Chinese households are estimated to control some US$41 trillion in financial assets as of 2022, yet equity allocation remains only around 12 per cent – far below the roughly 40 per cent seen in US households. The bulk is still tied up in bank deposits and China’s beleaguered property sector. With bond yields below 2 per cent and real estate offering little prospect of recovery in the near term, stocks have become effectively the last major asset class capable of delivering meaningful wealth creation.

Recent initiatives announced by Beijing suggest it is deliberately encouraging this shift to avoid the Japan-style stagnation trap and instead cultivate a US-style equity-driven “wealth effect”. Ongoing capital-market reforms, national-team stock purchases, and directives funnelling insurance and pension fund money into equities all signal strong – and crucially, ongoing – policy commitment. Analysts suggest even a modest 5 to 10 per cent increase in equity weighting could release an estimated US$2 trillion to 4 trillion in incremental buying power over the coming years.

The base case for China equities into 2026 is constructive, facilitated by structural reallocation, sustained policy backing, and potential foreign inflows amid dollar weakness

US dollar down, China up

A parallel global tailwind is emerging from US dollar weakness. After peaking earlier in the decade, the USD Index (DXY) softened during 2024 and 2025 amid Fed rate cuts and policy uncertainty, with consensus forecasts pointing to further gradual declines into 2026. A weaker US dollar reduces the currency’s yield advantage and encourages risk-seeking investors, many of whom are heavily overweight expensive US stocks after years of outperformance, to diversify into higher-growth emerging markets. 

China, with its improving earnings outlook and attractive valuations, is well positioned to capture a significant share of these flows. Foreign capital inflows have accelerated sharply in 2025, and continued dollar softness could amplify this external support alongside the domestic reallocation story. Should the RMB appreciate versus the USD in 2026 – an intriguing prospect floated by President Xi himself last week – foreign capital inflows could accelerate and increase even more.

Importantly, valuations remain reasonable even after 2025’s rally. The CSI 300 Index trades at 17 times trailing price-to-earnings and 16 times forward, with analysts projecting punchy 13.4 per cent earnings growth for 2026. Blue-chip dividend yields of 2.8 per cent forecasted in 2026, combined with improving corporate governance and rising payout ratios, support the potential for compounded annual returns of 10 to 12 per cent over a three- to five-year horizon.

At Lombard Odier, we remain comfortable deriving our exposure to China via our emerging market overweight

Risks remain

What about geopolitics? Beijing’s stranglehold on the production and supply of rare earths suggests the temporary geopolitical reprieve with the US will likely continue. For example, the late-2025 US-China trade truce has lowered tariffs and paused further escalation until late 2026, easing pressure on exporters and contributing to the year-end surge. Extraordinarily, China’s trade surplus for 2025 has exceeded US$1 trillion, further bolstering (domestic) market sentiment.

But as the medium-term shift towards de-globalisation gathers pace, trade tensions with developed market partners are likely to grow. A renewed Trump-era tariff push could spark foreign capital outflows, especially given foreigners’ still-underweight positioning. Domestic headwinds including high youth unemployment, and unfavourable demographics will continue to constrain nominal growth. Also, policy delivery could fall short if local-government debt concerns lead to restrained stimulus. And after a strong 2025, valuations are no longer at crisis lows, increasing the likelihood of normal 15 to 20 per cent corrections even within a broader uptrend.

But when is all said and done, the base case for China equities into 2026 is constructive, facilitated by structural reallocation, sustained policy backing, and potential foreign inflows amid dollar weakness. But note this positive outlook presupposes no major trade disruption or deepening deflation which would limit outcomes to flat or negative performance. Therefore, at Lombard Odier, we remain comfortable deriving our exposure to China via our emerging market overweight given China stocks are responsible for fully 28 per cent of the MSCI Emerging Market Index.

Read more about our wider Asia’s 2026 outlook here.