Navigating Trade Tensions: Why China's Domestic-Driven Services Sectors Offer Resilient Investment Opportunities

As U.S.-China trade tensions simmer, Chinese services firms are proving their mettle by pivoting toward domestic demand and supply chain diversification. While manufacturing sectors face headwinds from tariffs and overcapacity, the services sector—bolstered by government stimulus and tech-driven innovation—is emerging as a bastion of resilience. Investors seeking exposure to China's economy should focus on firms anchored to domestic priorities, such as healthcare, tech infrastructure, and consumer services, while avoiding sectors overly reliant on exports.

Services Lead the Way: PMI Data Highlights Divergence

The latest Purchasing Managers' Index (PMI) data underscores a stark divide between China's services and manufacturing sectors. In May 2025, the Caixin China General Services PMI rose to 51.1, signaling modest expansion driven by stronger domestic demand and business confidence. Meanwhile, the manufacturing sector's PMI plummeted to 48.3—its lowest level in over two years—due to weakening global demand and trade uncertainties.

This divergence reflects a structural shift: services are increasingly insulated from trade volatility through their reliance on China's vast domestic market. For instance, the retail sector—fueled by government subsidies and tech-driven logistics—saw sales grow 5.1% year-on-year in April 2025, supported by initiatives like the consumer goods trade-in program.

How Services Firms Are Mitigating Tariff Risks

1. Domestic Demand Focus:
   Services firms are capitalizing on China's “dual circulation” strategy, which prioritizes domestic consumption and innovation. E-commerce giants like Alibaba and JD.com are expanding their logistics networks to serve rural markets, while healthcare providers are ramping up telemedicine services to meet rising demand for affordable care.

2. Tech-Driven Diversification:
   Companies in cloud computing, fintech, and AI are reaping benefits from government-backed infrastructure spending. For example, Tencent Cloud's expansion into enterprise solutions and Baidu's autonomous driving initiatives are reducing reliance on export-sensitive hardware manufacturing.

3. Cost Management Amid Deflation:
   Despite rising input costs (up 7% year-on-year in May), services firms are mitigating margin pressure through efficiency gains. Output prices fell for the fourth straight month, with discounts boosting sales—a strategy that works when demand remains stable.

Sectors to Watch—and Avoid

Investment Opportunities:
- Healthcare: Firms like Ping An Good Doctor and United Imaging Healthcare are positioned to capitalize on aging demographics and government healthcare spending.
- Tech Infrastructure: Cloud providers and cybersecurity firms (e.g., Alibaba Cloud, Hillstone Networks) benefit from long-term tech upgrades.
- Consumer Services: Retailers with strong online-offline integration (e.g., Suning, Xiaomi) and travel companies (Ctrip) are well-placed to serve China's rebounding domestic tourism.

Sectors to Avoid:
- Export-Heavy Manufacturing: Sectors like textiles, electronics, and machinery remain vulnerable to tariffs and overcapacity.
- State-Owned Enterprises: Many SOEs in heavy industries (steel, cement) face deflationary pressures and weak demand.

Risks and Policy Tailwinds

While services firms are navigating trade tensions effectively, risks persist. Deflation (CPI at -0.2% in May) could dampen consumer spending, while unresolved U.S.-China disputes might prolong export-sector pain. However, policymakers are acting decisively: the People's Bank of China's recent rate cuts and RRR reductions have injected ¥1 trillion in liquidity, while fiscal measures like ultra-long-term bonds fund infrastructure projects.

Conclusion: Selective Exposure to Domestic Growth

The data and trends are clear: Chinese services firms anchored to domestic demand and innovation are outperforming their export-reliant peers. Investors should prioritize equities in healthcare, tech infrastructure, and consumer services while steering clear of manufacturing sectors exposed to trade headwinds. As the economy bifurcates, the winners will be those who bet on China's homegrown growth story.