China's GDP Growth: Manufacturing Shines as Policy and Trade Risks Linger

China's second-quarter GDP growth of 5.2% for 2025, narrowly exceeding forecasts, masks a stark divergence between sectors. While industrial production and export-driven manufacturing have surged, retail sales and the real estate sector continue to lag, creating a mosaic of opportunities and risks for investors. Amid policy stimulus and looming trade uncertainties, the equity market's performance will hinge on navigating this duality.

The resilience of industrial activity is undeniable. Industrial output expanded by 6.8% year-on-year in Q2, outperforming expectations of 5.7%. Key drivers included robust export demand from Southeast Asia (+13%) and the EU (+6.6%), offsetting a 10.9% decline in U.S. exports due to trade tensions.

. The oil processing sector grew by 1.6% in the first half of the year, while steel production, though weaker, stabilized. This underscores the sector's ability to adapt to shifting trade dynamics.

However, domestic demand remains a concern. Retail sales in June grew only 4.8% year-on-year, below forecasts of 5.4%, marking a slowdown from May's 6.4%. Weakness in discretionary categories like automobiles (-4.4% in Q1) and petroleum products (-1.9%) reflects cautious consumer sentiment. Fixed asset investment, a key indicator of economic momentum, grew just 2.8% in the first half—a tepid figure that underscores underlying fragility.

The real estate sector, once a pillar of growth, continues to drag. Property investment fell 11.2% year-on-year in H1, with prices in major cities declining despite policy efforts. While the National Bureau of Statistics notes “stabilization” in certain markets, the sector's contraction remains a critical headwind. The Federal Reserve's analysis highlights that the property bust has turned a historical contributor of over 1% to GDP growth into a material drag.

Policy and Trade Crossroads
The government's response has been proactive but insufficient. Measures such as the CNY 4 trillion loan program for stalled housing projects and “white list” support for developers have yet to revive confidence. With urban unemployment stuck at 5% and migrant joblessness elevated, policymakers face pressure to deploy more aggressive fiscal stimulus—potentially including targeted tax cuts and subsidies for households.

Trade uncertainties loom large. The August deadline for U.S.-China tariff negotiations poses a critical risk. If tariffs remain elevated, export-driven sectors like machinery and electronics could face renewed pressure. Conversely, a resolution might unlock pent-up demand. For now, the diversification of trade toward Asia and Europe—evident in export data—offers a buffer but not immunity.

Investment Strategy: Sector-Specific Opportunities
1. Overweight Export-Driven Manufacturing:
Companies exposed to ASEAN and EU markets, such as machinery, automotive components, and consumer electronics, are well-positioned. Strong export data and geographic diversification mitigate U.S. trade risks. Sectors like industrial equipment (e.g., robotics, automation) benefit from both domestic upgrading and global demand.

1. Underweight Real Estate Until Policy Clarity:
   The sector's recovery hinges on a sustained price stabilization and credible debt-resolution plans. Until August's trade deadline passes—and concrete fiscal measures are announced—valuation risks remain elevated. Even “white-listed” developers face overcapacity and weak demand.

2. Monitor Consumption for Bottoming Signals:
   Retail sales' weakness reflects broader income and wealth concerns. A rebound could emerge if households see sustained wage growth or property markets stabilize. Monitor categories like discretionary goods (e.g., appliances, sports equipment) for early signs of recovery.

Risks to the Outlook
- Trade Escalation: A failure to resolve tariffs could derail export momentum.
- Policy Delays: Fiscal stimulus may come too slowly to offset deflationary pressures.
- Housing Market Collapse: A further decline in property prices could trigger broader financial instability.

Conclusion
China's Q2 GDP figures reveal a bifurcated economy: industrial strength contrasts with domestic demand weakness and real estate malaise. Investors should capitalize on export-driven manufacturing's resilience while avoiding real estate until policy and trade clarity emerge post-August. The path to sustained growth remains narrow, requiring deft navigation of sector-specific dynamics and geopolitical risks. The equity market's next leg upward will depend on whether policymakers can bridge this divide—and whether external trade clouds finally part.

Recommendation: Overweight industrial and export sectors; underweight real estate until Q3 policy clarity.