China's Weakening Domestic Demand and Its Implications for Consumer and Industrial Sectors

China's domestic consumer market in 2025 is navigating a complex web of challenges: slowing retail growth, persistent youth unemployment, and policy uncertainty. These factors are reshaping investment strategies, with sector rotation and defensive positioning emerging as critical tools for navigating the evolving landscape.

The Fragile Consumer Outlook

Retail sales growth in Q2 2025 decelerated to 4.8% year-on-year in June, the weakest since February 2025, as consumer spending across key categories—gold jewelry, sports and entertainment, and household appliances—showed sharp moderation. The broader economic context is equally sobering: real estate investment fell 11.2% in H1 2025, while the PPI has contracted for 31 consecutive months, signaling deep-seated deflationary pressures. Meanwhile, the U.S.-China trade war, exacerbated by Trump-era tariffs, has further eroded business and consumer confidence.

The result is a shift in household behavior. Total deposits reached 163 trillion RMB in H1 2025, with savings rates remaining above 30% since 2020. While the 618 Shopping Festival saw a 15.2% GMV growth, this was driven by niche segments like electric vehicles (EVs) and health products, not broad-based spending. The EV sector, now accounting for 50% of China's passenger vehicle market, remains a rare bright spot, with domestic automakers like BYD dominating.

Strategic Sector Rotation: Defensive Sectors in Focus

Investors are increasingly favoring sectors with stable cash flows and low volatility. Infrastructure, consumer staples, and utilities have emerged as defensive pillars, supported by government stimulus and structural demand.

1. Infrastructure:
   Government-led fiscal stimulus in transportation, energy, and digital infrastructure has provided a buffer against broader economic headwinds. The manufacturing PMI, which has remained below 50 since early 2025, underscores the need for capital-intensive projects to sustain employment and GDP growth. Investors are advised to monitor state-owned enterprises (SOEs) and private firms involved in green energy and 5G expansion.

2. Consumer Staples:
   Food and beverage, household goods, and essential services have shown resilience despite deflationary pressures. The Services PMI (51.1 in May 2025) outperformed the contracting manufacturing sector, highlighting the sector's stability. Targeted subsidies for trade-ins in appliances and EVs, part of a 300-billion-RMB stimulus package, are expected to provide short-term tailwinds.

3. Utilities:
   The push for decarbonization and renewable energy has elevated utilities as a high-conviction play. Solar and wind capacity expansions, coupled with regulated pricing models, offer predictable cash flows. The sector's low debt burdens and alignment with China's net-zero goals make it a compelling long-term bet.

Policy Uncertainty and the Dual Circulation Strategy

The government's “Dual Circulation” strategy—prioritizing domestic demand while maintaining global connectivity—has introduced a mix of reforms. These include easing residency laws, expanding social security, and liberalizing tax thresholds for rural residents. However, the effectiveness of these measures remains constrained by the property sector's collapse and shadow banking contraction.

Investors must also contend with trade policy risks. While the May 2025 U.S.-China trade deal reduced tariffs, concerns persist over potential retaliatory measures from the EU and Mexico. Defensive positioning in sectors less exposed to global trade volatility—such as utilities and consumer staples—is increasingly prudent.

Industrial Sector Rebalancing

The industrial sector is undergoing a painful but necessary rebalancing. Overcapacity in manufacturing, particularly in steel and cement, has led to weak PPI readings. However, high-tech industries—information services, e-commerce, and aerospace—have seen robust investment growth (9.7% in H1 2025). This divergence highlights the need for selective exposure to innovation-driven subsectors.

Investment Advice: Balancing Growth and Defense

For investors, the key lies in diversifying across defensive and growth-oriented sectors. A portfolio could include:
- High-quality consumer staples (e.g., food and beverage firms with strong brand loyalty).
- Infrastructure-linked equities (e.g., SOEs in energy and transportation).
- Renewable energy utilities (e.g., solar and wind operators).
- EV supply chain players (e.g., battery manufacturers and charging infrastructure firms).

Currency forwards and cash allocations are also recommended to hedge against policy-driven volatility. While the government's rate cuts and liquidity injections may provide temporary relief, structural challenges—such as the property sector's collapse—will require sustained intervention.

Conclusion

China's 2025 economic landscape is defined by duality: a fragile consumer sector and a resilient industrial base in strategic areas. Defensive positioning in infrastructure, consumer staples, and utilities offers a counterbalance to the risks of deflation, unemployment, and policy uncertainty. Meanwhile, selective exposure to high-tech and EV sectors can capture long-term growth. As the government navigates its Dual Circulation strategy, investors must remain agile, prioritizing flexibility and liquidity in an environment where certainty is elusive.