Navigating China's Non-Manufacturing Growth: Opportunities in Services and Construction Amid Sectoral Divergence

The Chinese economy's recent performance has been marked by a stark divide between its manufacturing and non-manufacturing sectors. While manufacturing continues to contract—dragged down by U.S. tariffs and weak demand—the non-manufacturing sector (including services and construction) has shown resilience, with its Purchasing Managers' Index (PMI) rising to 50.5 in June 2025 from 50.3 in May. This slight expansion signals stabilization in key growth drivers like infrastructure spending and domestic consumption. For equity investors, this divergence presents sector-specific opportunities, particularly in construction and service-oriented industries, while caution is warranted in manufacturing.

Sector-Specific Growth Drivers

1. Construction: Infrastructure as a Catalyst

The construction sector's contribution to the non-manufacturing PMI's rise is evident. Government-backed infrastructure projects—such as transportation upgrades and urban renewal—are key growth engines. The National Bureau of Statistics highlighted improved construction activity in June, driven by fiscal stimulus and policy support. For instance, cities like Chengdu and Hangzhou are prioritizing smart city initiatives, boosting demand for construction materials and specialized firms.

Investors should monitor firms like China State Construction Engineering (CSCEC), which benefits from state-led projects, and infrastructure REITs (Real Estate Investment Trusts) tied to toll roads or commercial real estate. However, risks persist: U.S. tariffs on steel and HVAC equipment (cited in May's PMI data) could pressure margins unless companies secure alternative supply chains.

2. Services: Domestic Consumption's Quiet Recovery

The services sector's expansion—though not explicitly quantified in June's PMI—aligns with trends in retail, healthcare, and education. Premier Li Qiang's push to turn China into a “consumption powerhouse” has spurred growth in tourism, e-commerce, and healthcare. For example, Accommodation & Food Services reported steady demand in May's U.S. PMI data (a proxy for global trends), suggesting resilience in travel and hospitality.

Opportunities here include:
- E-commerce platforms (e.g., Alibaba's Taobao) benefiting from online retail growth.
- Healthcare providers (e.g., United Imaging Healthcare) leveraging aging demographics and government subsidies.
- Education tech firms (e.g., New Oriental Education) as post-pandemic demand for skill development rises.

3. Utilities and Public Administration: Steady but Underappreciated

The utilities sector's expansion in May—driven by data center and commercial infrastructure projects—hints at long-term demand for energy and tech infrastructure. Meanwhile, public administration's PMI improvement reflects fiscal spending on public services, even amid budget cuts.

Valuation Opportunities: Where to Deploy Capital

1. Construction and Infrastructure Stocks

• Target: Firms with strong government ties and exposure to urbanization projects.
• Example: China Railway Group (not publicly traded but part of state-owned enterprises) or listed peers like CRRC Corporation Limited (06886.HK).
• Risk Mitigation: Diversify into companies with international contracts (e.g., Sinohydro) to reduce reliance on domestic demand.

2. Service Sector Plays with Growth Profiles

• Target: Companies in healthcare, education, and tech-enabled services.
• Example: Wuhan Guotai Medicine (healthcare innovation) or TAL Education (post-pandemic education recovery).
• Valuation Check: Look for firms with PEG ratios below 1.5, indicating growth undervalued relative to earnings.

3. ETFs for Broad Exposure

• CSI 300 Consumer Discretionary ETF (510130): Tracks leading service and retail firms.
• KWEB (KraneShares CSI China Internet ETF): Captures the digital economy's role in services.

Risks and Challenges

1. Trade Tensions: U.S. tariffs remain a wildcard. The June PMI noted that exporters are shifting production to Southeast Asia to bypass restrictions, but this requires time and capital.
2. Deflationary Pressures: Consumer prices fell 0.1% in May, squeezing profit margins for service providers.
3. Debt Concerns: Construction firms with high leverage (e.g., Evergrande's legacy issues) pose credit risks.

Investment Strategy: Selective and Sector-Agnostic

• Focus on non-manufacturing equities: Allocate 60% to services/construction and 40% to defensive sectors like utilities.
• Avoid manufacturing stocks: Unless they show clear tariff mitigation strategies (e.g., relocating production).
• Monitor the Caixin Non-Manufacturing PMI: The June forecast of 52.4 (long-term) could validate the sector's durability.

Conclusion

China's non-manufacturing sector is a bright spot in an otherwise uneven recovery. Investors should prioritize construction firms tied to infrastructure and service-sector companies benefiting from domestic consumption. However, vigilance is required: tariff risks and deflation could disrupt even the strongest sectors. For now, the PMI data suggests selective optimism is warranted, but the path to sustained growth hinges on resolving trade disputes and reigniting global demand.

Final Note: Keep an eye on the July PMI release for confirmation of June's expansion trend. If the non-manufacturing index holds above 50.5, it could signal a turning point for equity markets in these sectors.