China's Shifting Capital Allocation: Why Bond Bulls Are Losing Ground to Equity Optimism

The capital allocation landscape in China is undergoing a seismic shift as investors increasingly pivot from the relative safety of bonds to the high-growth potential of equities. This reallocation is being driven by a confluence of factors: the re-rating of tech stocks, policy-driven optimism in shareholder returns, and the delayed easing of monetary policy. While bond markets remain anchored by stabilization in the property sector and industrial debt, equities are capturing risk appetite with AI-driven narratives and policy tailwinds.

The Bond Market: Stability, But Looming Caution

Chinese corporate bonds have benefited from structural improvements in key sectors. The property market, once a pariah for investors, is showing early signs of recovery. Early bond redemptions by major developers and the successful refinancing of distressed entities have rekindled confidence in USD-denominated property bonds. Industrial bonds, with their limited supply and robust credit fundamentals, have also drawn inflows. However, this optimism is tempered by caution. Investors are taking profits in overvalued state-owned enterprise (SOE) bonds and remain wary of trade-related risks, particularly in banking and export-dependent sectors.

Monetary policy in China has been slower to ease compared to global peers. While the People's Bank of China (PBoC) has cut interest rates and reserve requirement ratios (RRRs) in 2025, these measures have lagged behind the aggressive easing seen in the U.S. and Europe. This has kept bond yields relatively low, with 10-year Chinese government bonds offering a yield of 1.7%—far below the 3% dividend yields now available in equities. As a result, bond bulls are finding it harder to justify allocations in a low-yield environment, especially when equities promise both income and capital appreciation.

Equity Market: AI-Driven Re-Rating and Policy Tailwinds

The re-rating of Chinese equities has been nothing short of dramatic. The launch of DeepSeek's R1 model in January 2025 ignited a frenzy in AI-related stocks, with Hong Kong-listed beneficiaries surging 45% and the Hang Seng Tech Index ETF rising 29%. This momentum has been amplified by policy interventions. In January 2025, regulators mandated that mutual funds and insurers boost their equity holdings, effectively injecting liquidity into the market. These measures, combined with record dividend distributions (2.4tn yuan in 2024) and buybacks (147.6bn yuan), have made equities a compelling alternative to bonds.

The AI boom is reshaping investor positioning. Sectors like autonomous driving, robotics, and cloud computing are seeing capital inflows, with companies like Alibaba and BYD leading the charge. Alibaba's $52 billion AI capital expenditure plan, for instance, signals a long-term commitment to monetizing AI-driven efficiencies. Meanwhile, the EV sector is leveraging AI to enhance autonomous driving capabilities, creating a flywheel effect for growth.

However, the rally is concentrated. Non-AI MSCI China stocks have gained only 10% year-to-date, compared to 19% for the broader index. This dispersion underscores the importance of selectivity. Investors are advised to focus on genuine AI beneficiaries with strong execution capabilities rather than speculative plays.

Delayed Monetary Easing and Currency Dynamics

The PBoC's slower pace of easing has had a ripple effect on the yuan (CNH). While the CNH strengthened from 6.4 to 7.4 in 2025 due to narrowing U.S.-China rate differentials, this trend is expected to reverse as the Fed tightens further and the PBoC continues to ease. The wide negative carry on the CNH and lingering U.S. tariff risks suggest downward pressure on the currency. Investors holding CNH exposure are advised to hedge or use it as a funding currency.

Investment Implications: Balancing Risk and Reward

For investors, the shift from bonds to equities requires a nuanced approach. While the equity rally is justified by AI-driven growth and policy support, the sustainability of the gains remains uncertain. Earnings upgrades in AI-related sectors may take years to materialize, and valuations in some tech stocks are approaching overbought levels. Structured products with downside protection could offer a balanced way to participate in the rally.

On the bond side, property and industrial sectors still present opportunities, but investors must remain selective. High-yield property bonds, for instance, require rigorous due diligence, while industrial bonds may offer defensive appeal in a volatile environment.

Conclusion: A New Equilibrium in China's Markets

China's capital allocation dynamics are being reshaped by AI, policy, and monetary policy delays. While bond markets provide stability, equities are capturing the imagination of investors with their growth potential. The re-rating of tech stocks and government-driven shareholder return initiatives have created a fertile ground for risk-on positioning. However, the path forward will demand a careful balance between capitalizing on innovation and managing the risks of overvaluation and macroeconomic fragility. For now, the bulls of Chinese equities are winning—but their edge depends on execution, not just optimism.