China: up the value chain

China’s climb up the manufacturing value chain is reshaping industries and global profit pools. China’s 2001 entry into the World Trade Organization unleashed what some academics called the “China shock”: cheap, labor-intensive exports soared, but so did imports as China became embedded in global supply chains. Made in China 2.0 looks different. State support has helped China rapidly gain market share in cutting edge industries like EVs, advanced machinery and AI, backed increasingly by its own supply chains. This means while China’s share of global exports has stayed steady, what it sells has moved decidedly upmarket. At the same time, its import share has fallen from its 2021 peak as domestic demand trails production. See the chart. The result is greater competition for producers globally, even as lower-cost Chinese technology benefits end users.

Outside China, the key question is whether companies use Chinese technology or compete against it. Cheaper Chinese industrial robots and machinery can boost productivity and ease labor shortages for their customers. For rival producers, the economics are less appealing. European machinery makers illustrate the squeeze. China has moved from a major buyer of advanced machinery to a formidable competitor at home and abroad. In 2025, it overtook Germany as the world’s largest machine-tool exporter for the first time.

AI creates a similar divide. Cheaper Chinese models could accelerate AI adoption while commoditizing the model market. That could shift value toward the physical infrastructure needed to support greater AI use - computing power, data centers and electricity - reinforcing the scarcity investment theme from our Midyear Global Outlook. Physical AI could amplify demand for power electronics and batteries while broadening demand for components like motors and actuators – areas where China already has a manufacturing and supply-chain advantage. But technology sovereignty cuts both ways: export controls and efforts to reduce reliance on Chinese technology could limit market access. That makes geopolitics a key risk to where the opportunity ultimately lies.

Inside China, industrial policy has helped build scale and competitiveness, but growth alone does not guarantee shareholder returns. Long-standing challenges – including weak domestic consumption, a soft property market and an aging population – remain, while intense competition can squeeze margins even in industries where China has gained global market shares. The divergence is stark: profits at Chinese electronic-device makers rose 110% year over year in the first seven months of 2026, supported by global AI demand, while auto profits fell 20.4%, according to data from the National Bureau of Statistics of China. Likewise, AI hardware suppliers have expanded margins, while solar manufacturers have seen theirs collapse. Markets echo that divide: the MSCI China index has lost 11% in U.S. dollar terms this year through Sept. 21, while the MSCI China Information Technology index has gained 7%.

This divide reinforces our selective approach: we stay neutral Chinese equities while favoring areas where growth is translating into stronger margins and returns – particularly in AI hardware and select advanced manufacturing.

The global bond selloff accelerated last week, pushing long-dated U.S. Treasury yields to their highest levels in over 20 years. The 30-year yield reached 5.53%, a level last seen in 2004, while the 10-year rose to a 19-year high of 5.22% on expectations for further rate hikes. We think markets may be getting ahead of themselves. A hike that strengthens Fed credibility, against a backdrop of stronger growth, is in our view on net good news for risk assets.

U.S. payrolls and inflation are in focus. Slower labor supply growth means softer job gains need not signal a weaker economy, in our view. We expect hiring around levels consistent with full employment – enough to keep wage pressures elevated and risk keeping inflation sticky. September PCE will show whether that pressure is feeding through, with core inflation still running above 3%.