Fast reading
- China remains a contrarian trade, with global investors still cautious amid macro, regulatory, and geopolitical headwinds.
- Hong Kong is outperforming: The Hang Seng Index is up +21.6% YTD1, its strongest relative run versus onshore China since 2008.
- Mainland investors are driving the rally, rotating into Hong Kong via southbound Stock Connect – which allows mainland Chinese investors to access the Hong Kong market – amid concerns over China’s domestic outlook.
- Foreign institutional flows remain light, with hedge funds leading activity – signalling a tactical, not structural, re-engagement.
Could the China trade make a comeback? That was a question for investors to mull this week as Washington and Beijing signed a trade deal that appeared to formalise an earlier handshake agreement.
James Cook, Investment Director for Emerging Markets at Federated Hermes Limited, notes that, over the past four years, global capital has chased the relative safety and performance of the US tech sector. In contrast, investors have viewed Asia – and India, Taiwan and China in particular – as increasingly un-investable.
“The macroeconomic headwinds, regulatory overhang, and geopolitical tensions made it easy for investors to stay away – and many did,” he says. “The rise of ‘GEMs ex-China’ strategies has been a clear signal: investors haven’t just been underweight China; they have actively excluded it.”
Fast forward to today, however, and the narrative appears to be shifting – at least in Hong Kong. The Hang Seng Index has surged 23.2% year-to-date (YTD), marking its strongest relative outperformance versus the CSI 300, the mainland China blue-chip Index, since 2008, which has delivered 2.2% YTD.2
“This divergence is striking and speaks volumes about where investor confidence lies within the broader China complex,” says Cook.
Figure 1: How the Hang Seng soared
Data suggests that the rally in Hong Kong has been driven not by foreign inflows, but by domestic capital — specifically, mainland investors accessing the market via Southbound Connect (see Figure 2 below).
For Cook, this reflects a mounting concern over China’s domestic economy, meaning investors are looking outward, with Hong Kong’s tech-heavy listings and recovering IPO pipeline offer a compelling alternative. “Giants like Tencent and Alibaba — listed in Hong Kong and the US, but not onshore — have become key vehicles for this rotation. Alibaba’s September listing upgrade, which made it eligible for Southbound flows, was a pivotal moment,” he adds.
Figure 2: Hong Kong – southbound fund inflows vs. the Hang Seng
Hong Kong is rallying – but it’s not a broad-based vote of confidence in China.
Yet, despite the rally, foreign institutional investors remain largely on the sidelines. Flows have been predominantly from hedge funds – tactical, short-term capital – rather than long-only money making a structural return, notes Cook, adding that scars from past drawdowns run deep.
“Even the excitement around China’s AI ambitions, briefly reignited by DeepSeek’s GenAI launch in January, has been tempered by a series of geopolitical flashpoints: ‘Liberation’ Day’ tariffs, and uncertainty as the end of the 90-day tariff pause looms,” he adds.
“In short, Hong Kong is rallying – but it’s not a broad-based vote of confidence in China. It’s a tactical trade, driven by domestic capital and selective optimism. For foreign investors, the bar for re-engagement remains high.”
The nuance behind the news
Elsewhere, investors continue to consider the impact of the so-called US dollar flight.
Here, the recent US strikes on Iran and the resulting spike in oil prices have added to an already volatile and unpredictable global economic backdrop – with Moody’s recent downgrade of US creditworthiness and anaemic performance by US bonds and the US dollar all contributing to a growing ‘sell America’ narrative.
Lewis Grant, Senior Portfolio Manager, Global Equities, Federated Hermes Limited, notes that, while the US macro picture remains mixed, hard economic indicators continue to show resilience. In addition, he says, investors are closely watching the passage of the so-called ‘One Big, Beautiful Bill Act’, which is expected to be broadly supportive of risk assets.
“All of this makes for a nuanced picture,” Grant says. “The expiration of the 90-day tariff truce on 9 July is likely to bring trade tensions back into focus, adding another layer of complexity. But, if progress is made – either through a resolution or extension of the tariff pause and/or the successful passage of the bill – sentiment toward US markets could improve meaningfully.”
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1 Source: Bloomberg as at 24 June 2025.
2 Ibid.
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