Navigating China's Industrial Decline: Where to Find Resilience and Opportunity

China's industrial profits plunged 9.1% year-on-year in May 2025, marking the steepest decline since October 2024. The broader trend of a 1.1% drop in cumulative profits through May underscores a fragile recovery amid deflationary pressures, weak domestic demand, and U.S. trade tensions. Yet within this gloomy backdrop, select sectors are emerging as beacons of resilience, driven by strategic shifts in trade and innovation. Investors should focus on firms mitigating U.S. tariff risks through export diversification, high-tech specialization, and infrastructure upgrades—while remaining cautious on sectors plagued by overcapacity and deflation.

The Decline: A Sectoral Divide

The industrial slowdown is uneven. State-owned enterprises (SOEs), which dominate traditional industries like mining and heavy manufacturing, saw profits fall 7.4% in the first five months of 2025. Meanwhile, private firms (excluding real estate) and foreign-invested enterprises posted modest gains (0.3% and 3.4%, respectively), reflecting agility in adapting to market shifts.

Deflationary headwinds are compounding the pain. The Producer Price Index (PPI) fell 3.3% in May, with input costs dropping 3.6%, squeezing margins for commodity-heavy sectors. The automotive industry—battered by price wars and excess supply—saw dealer cash flow collapse, while textiles and apparel profits fell 12.7%.

Resilience: High-Tech and Export Diversification

The brightest spots lie in sectors insulated from trade wars and positioned to benefit from structural shifts:

1. Electric Vehicles (EVs) and High-Tech Manufacturing
   EV production rose 31.7% year-on-year, with firms like NIO and Zeekr capitalizing on subsidies and trade-in programs. High-tech manufacturing profits surged 9%, driven by robotics (35.5% growth), industrial 3D printing (40%), and semiconductors. These sectors are less exposed to U.S. tariffs and more aligned with Beijing's “domestic substitution” agenda amid U.S. tech restrictions.

1. Southeast Asia and EU Export Plays
   While U.S. exports fell 8.5% in May, China's trade diversification bore fruit: exports to ASEAN grew 10.5%, and EU exports rose 3.2%. Firms with strong supply chains in electronics, machinery, and consumer goods (e.g., Haier, Midea) are benefiting.

2. Infrastructure and Logistics
   Beijing's push to upgrade infrastructure—5G, EV charging networks, and smart cities—is creating demand for firms like ZTE (telecom) and State Grid (electricity). Meanwhile, logistics companies (e.g., Cainiao) are critical to sustaining export growth.

Geopolitical Dynamics: Navigating Tariffs and Trade

The U.S.-China trade war continues to reshape industrial strategy. The Geneva framework's 90-day tariff pause offers temporary relief, but unresolved issues like semiconductor restrictions linger. Companies are responding by:
- Rerouting Supply Chains: Shifting production to Vietnam and Malaysia to avoid U.S. tariffs.
- Focusing on Non-U.S. Markets: ASEAN's rising middle class and EU's green tech demand are key growth vectors.

Risks to Avoid: Deflation and Overcapacity

Investors should avoid sectors with chronic overcapacity or exposure to deflation:
- Mining and Non-Metallic Minerals: Profits dropped 26.8% and 49.9%, respectively, due to weak commodity prices and oversupply.
- Textiles and Apparel: Marginal businesses unable to pivot to luxury or sustainable fabrics risk further declines.
- Property-Linked Industries: The real estate slump (fixed asset investment down 10.7%) continues to drag on cement, steel, and machinery makers.

Investment Strategy: Tactical Bets on Flexibility

1. Tilt Toward Export Diversification Leaders:
2. SEEs: Haier (household appliances), ZTE (telecom), and BYD (EVs) have strong non-U.S. market exposure.

3. ETFs: Consider the FTSE China High-Tech 50 Index, which tracks firms in semiconductors, robotics, and AI.

4. High-Tech Infrastructure Plays:

5. 5G and EV Infrastructure: Firms like State Grid (EV charging) and FiberHome (telecom) benefit from policy spending.

6. Avoid Overcapacity Traps:

7. Steer clear of coal, steel, and textiles unless valuations reflect distressed conditions.

8. Stay Agile on Policy Signals:
   Monitor July's Politburo meeting for stimulus measures (e.g., tax cuts for SMEs, targeted credit).

Conclusion

China's industrial sector is bifurcating between declining legacy industries and emerging high-tech/export-driven winners. Investors should focus on firms with diversified export bases, innovation moats, and exposure to infrastructure upgrades. While deflation and policy uncertainty remain risks, tactical allocations to resilient sectors can navigate the decline—and capture the next wave of growth.

Stay nimble, and prioritize flexibility in a shifting landscape.