China's 2Q GDP slowed, but AI and Semiconductors are driving the next growth cycle

2Q Economic Data at a Glance

China's second-quarter GDP growth slowed to 4.3% year-on-year, down from 5.0% in the first quarter, but the headline masks a significant structural shift within the economy. Growth remained within the government's 4.5%–5.0% annual target range, with first-half GDP expanding 4.7% to RMB69.57 trillion. More importantly, the slowdown was narrowly concentrated in the property sector rather than reflecting broad-based economic weakness.

Real estate remained the economy's principal drag. Fixed asset investment fell 5.7% in the first half, but the decline narrowed to 2.7% once real estate development was excluded, highlighting the sector's disproportionate impact. Likewise, weakness in consumer spending was concentrated in big-ticket purchases, with June auto sales falling 16.1%, while retail sales excluding automobiles still grew 3.0%.

There were also early signs that deflationary pressures may be easing. Nominal GDP expanded 5.9%, outpacing real GDP growth and implying a 1.6% GDP deflator, the first positive reading in roughly thirteen quarters. As corporate revenues and earnings are more closely linked to nominal rather than real economic growth, this represents a constructive signal for equity investors.

Indicator	2Q26	1H26	Commentary
Real GDP (YoY)	+4.3%	+4.7%	1H26 within the 4.5%–5.0% target range
Nominal GDP (YoY)	+5.9%	—	GDP deflator +1.6%, first positive reading in ~13 quarters
Goods Trade (Imports + Exports)	+18.4%	+16.9%	2Q growth was the fastest since 3Q 2021; exports +13.4%, an 11-quarter growth streak
Compute Hardware Trade	—	+56.6%	Electronic components, computer parts, etc.; RMB 5.13tn
High-tech Product Exports	—	+39%	RMB 3.26tn; integrated circuit exports +approx. 96%
Fixed Asset Investment	—	−5.7%	-2.7% excluding real estate development; real estate development investment -18.0%
Total Retail Sales of Consumer Goods	+1.0% in June	+1.3%	Services retail sales +5.3%; autos (-16.1%) the largest drag

Source: National Bureau of Statistics, General Administration of Customs; compiled by iFAST Research

Data as of 15 July 2026

While domestic demand softened, external demand accelerated sharply and became the primary engine of growth. China's goods trade expanded 18.4% year-on-year in the second quarter, the fastest pace since the third quarter of 2021, with June alone recording 24.2% growth and extending a 17-month expansion streak. The composition of exports is even more significant than the headline growth.

AI-related products were the clear winners. First-half compute hardware trade rose 56.6%, integrated circuit exports nearly doubled, while high-tech product exports increased 39%. Electromechanical products accounted for 63.5% of total exports, up 3.5 percentage points from a year earlier. Manufacturing data tells the same story, with high-tech industrial output and semiconductor production both substantially outpacing overall industrial growth.

The defining feature of the quarter was the divergence between old and new growth drivers. While real estate development investment contracted 18.0%, compute hardware trade expanded 56.6%. This is more than a cyclical rotation—it marks a structural shift in China's economy. Just as property drove growth over the past two decades, AI, semiconductors and advanced manufacturing are increasingly assuming that role. This transition is also supported by policy. Under the 15th Five-Year Plan, information technology has been designated both an "emerging pillar industry" and a "future industry", reinforcing AI as a long-term national priority rather than a short-term stimulus initiative.

AI and Semiconductors: The Core Investment Case for Chinese Equities

The Global Compute Cycle: How External Capex Flows Through to China

Understanding China's information technology and semiconductor sector requires viewing it as a complementary AI ecosystem rather than a mirror of U.S. AI equities. While the U.S. leads in frontier computing—with cutting-edge GPUs, hyperscale cloud investment and state-of-the-art foundation models—China's competitive advantage lies in systems efficiency. Limited access to the most advanced process nodes has encouraged Chinese firms to optimise compute through large-scale GPU clusters, hardware-software co-optimisation and advanced networking technologies. These two ecosystems are complementary rather than mutually exclusive. U.S. equities provide exposure to frontier AI innovation, while Chinese equities offer exposure to the infrastructure and systems engineering that enable AI deployment at scale.

This distinction is increasingly important as global AI investment accelerates. North America's leading hyperscalers are expected to spend roughly USD725 billion on AI infrastructure in 2026, with several companies nearly doubling capital expenditure. While the market's attention has focused on GPU manufacturers, the spending cycle extends across the broader supply chain, benefiting AI servers, printed circuit boards (PCBs), optical modules, power supplies, thermal management systems and other critical components. China occupies a dominant position in many of these segments. Mainland manufacturers account for more than half of global PCB production and are deeply integrated into AI server supply chains serving leading international customers. The rapid growth in China's compute hardware and integrated circuit exports reflects this global investment cycle flowing directly into domestic manufacturers.

Several structural tailwinds are further strengthening earnings momentum across the sector. High-bandwidth memory (HBM) has entered a supply-constrained supercycle, with memory prices rising more than 70% this year and tight supply expected to persist into 2027. At the same time, demand for AI computing capacity has pushed compute rental into a seller's market, allowing domestic providers to raise prices. Meanwhile, AI adoption within China continues to accelerate. As enterprises move beyond chatbots towards AI agents capable of executing complex tasks, inference workloads are increasing rapidly, driving demand for servers, memory, semiconductor equipment and domestic AI chips.

The impact is already visible in corporate earnings. Constituents of the CSI All-Share Information Technology Index reported aggregate net profit growth of more than 70% year-on-year in the latest quarter, led by semiconductor and software companies. Rather than being driven by a handful of market leaders, earnings growth is broadening across the AI value chain, reinforcing our conviction that China's AI opportunity extends well beyond individual stocks to the sector as a whole.

Systems-Level Breakthroughs: A Technology Path Around Process Constraints

China's ability to capture the AI investment cycle rests on a different technological path from that of the United States. Rather than competing solely through leading-edge semiconductor manufacturing, Chinese companies are increasingly improving computing performance through systems engineering—combining hardware-software co-optimisation, large-scale computing clusters and advanced optical interconnects. This enables higher effective compute without relying exclusively on the most advanced process nodes, playing to China's existing strengths in networking infrastructure and system integration.

Huawei's proposed Tao's Law illustrates this approach. Instead of relying purely on geometric scaling to improve chip performance, it emphasises time-domain scaling, logic folding and system-level interconnects to extract greater computing efficiency from mature manufacturing processes. According to Huawei's public disclosures, the latest-generation Kirin chip achieved double-digit improvements in both density and energy efficiency within a single product cycle. While this does not eliminate China's reliance on advanced semiconductor manufacturing, it reduces the industry's dependence on continuously accessing the most advanced process nodes.

This technological progress is accelerating domestic substitution across the AI supply chain. Although export restrictions on advanced chips remain a near-term headwind, they have also encouraged greater adoption of domestic chips, servers and supporting infrastructure. By 2025, domestic suppliers accounted for more than 40% of chip sales within China, a share that continues to rise. Capacity expansion by CXMT and Yangtze Memory Technologies has further strengthened China's domestic memory ecosystem while supporting demand for upstream semiconductor equipment and materials.

Today, China has established competitive domestic players across almost every layer of the AI value chain—from foundation models and applications to computing infrastructure, chips, memory and energy. The increasing completeness of this ecosystem reduces dependence on any single technology bottleneck and strengthens the resilience of corporate earnings. We therefore view the current wave of domestic substitution not as a temporary response to export controls, but as a structural shift that is likely to support long-term growth across China's semiconductor and AI industries.

Policy Anchoring: An Industrial Priority Spanning the Entire Five-Year Plan

Policy provides the third pillar supporting China's AI investment cycle, with its strength lying in its long-term commitment rather than the scale of short-term stimulus. For the first time, AI+ was included in the Government Work Report as a standalone economic initiative, while information technology received the dual designation of both an "emerging pillar industry" and a "future industry." Together, these signal that AI is not simply a cyclical growth initiative but a national strategic priority embedded throughout the 15th Five-Year Plan (2026–2030).

This long-term commitment is being translated into concrete policy actions. The State Council has called for faster deployment of intelligent computing infrastructure and hyperscale data centres under the Eastern Data, Western Computing initiative, while the National Development and Reform Commission (NDRC) is promoting greater adoption of domestic AI chips by local large language models. At the regional level, provinces including Beijing and Guangdong have set targets to localise intelligent computing infrastructure by 2027, with at least 70% of new computing capacity sourced domestically.

Fiscal policy reinforces these initiatives. Ultra-long special treasury bonds and new policy-based financing tools are being directed towards technology innovation, semiconductor development and large-scale AI infrastructure projects. For investors, the significance lies less in the size of the fiscal support than in the visibility it provides. By anchoring demand for domestic chips, servers and AI infrastructure over multiple years, government policy reduces earnings uncertainty and supports a more durable investment cycle that is less dependent on short-term economic fluctuations.

Sector-Wide Momentum, Stock-Specific Risk

The four structural drivers outlined above—global AI capex, systems-level innovation, supportive policy and expanding AI infrastructure—point to one conclusion: China's AI and semiconductor sector enjoys strong earnings visibility over the medium term. However, that visibility is far less predictable at the individual stock level.

Leadership within the AI value chain rotates rapidly between semiconductors, memory, AI servers, printed circuit boards (PCBs), software and applications. As capital flows shift across sub-sectors, yesterday's market leaders can quickly become today's laggards, making precise timing both difficult and costly. Individual companies also face idiosyncratic risks, including export restrictions, customer concentration, execution challenges and rapid technological change, which can result in significantly greater volatility than the broader sector.

History suggests that during major thematic growth cycles, investors capture most of the excess returns through sector-level beta rather than stock-specific alpha. In other words, participating in the structural growth trend is often more important than identifying a handful of winners. Given the breadth of China's AI ecosystem and the pace of technological change, we believe a diversified, high-purity portfolio spanning the entire AI value chain offers a more robust and resilient way to capture the long-term opportunity than concentrated positions in individual companies.

Offshore Tech Assets: Valuations Near a Trough, with Improving Momentum

While onshore technology companies are already benefiting from the AI hardware investment cycle, offshore Chinese internet platforms offer a complementary opportunity driven by improving earnings and attractive valuations. Despite recent gains, the sector continues to trade near historical valuation lows after several years of intense competition, slowing e-commerce growth and heavy AI investment weighed on profitability.

Alibaba illustrates this transition. Over the past year, aggressive spending on cloud computing, AI, instant retail and user acquisition compressed margins and weighed on investor sentiment. As a result, the company's valuation fell to levels that increasingly reflected near-term earnings pressure rather than its long-term growth potential.

That investment phase is now beginning to translate into commercial returns. Preliminary quarterly results point to cloud revenue growth accelerating well ahead of market expectations, supported by improving cloud margins. At the same time, instant retail subsidy spending is moderating while market share remains stable, suggesting the business has moved beyond its most capital-intensive phase.

AI commercialisation is also gathering pace. Alibaba's large language model has been integrated into Apple's on-device AI services in China, providing third-party validation of its technology while significantly expanding its distribution reach beyond Alibaba's own ecosystem. More importantly, it demonstrates that the company's AI investments are beginning to generate tangible monetisation opportunities rather than remaining purely research expenditure.

The market has responded quickly. Alibaba's Hong Kong-listed shares recorded double-digit gains following these developments, with the Hang Seng TECH Index also rallying. This reflects a broader dynamic across the sector: when competitive pressures begin to ease and AI investment starts translating into visible revenue and earnings growth, companies trading at depressed valuations tend to experience disproportionate valuation re-rating. As AI monetisation accelerates and leading platform companies demonstrate improving profitability, we believe the foundations for a sustained earnings recovery across offshore Chinese technology are beginning to emerge.

Recommended Names and Positioning Framework

Based on our analysis, we recommend an equal-weight allocation to the GF China Securities All-Share Information Technology ETF (159939.SZ) and the Hang Seng TECH ETF (3067.HK). The former provides high-purity exposure to China's AI hardware ecosystem, capturing both the ongoing domestic semiconductor substitution theme and the benefits of rising global AI infrastructure spending. With close to 100% exposure to the information technology sector and a relatively diversified portfolio—the top 10 holdings account for approximately 27.6% of assets—it offers broad participation across the domestic semiconductor value chain. The Hang Seng TECH ETF complements this exposure by providing access to China's leading internet and AI platform companies, where the earnings recovery driven by AI monetisation and cloud growth is only beginning to emerge. Together, the two ETFs provide diversified exposure across both the hardware and platform segments of China's AI ecosystem.

For investors seeking broader exposure beyond technology, the T. Rowe Price Funds SICAV – China Evolution Equity Fund offers a complementary perspective by investing across the wider AI value chain. Industrials and commercial services account for 30.2% of the portfolio—more than three times the benchmark weighting of 9.5%—providing meaningful exposure to the physical infrastructure underpinning AI deployment, including upstream segments that a pure technology index does not capture.

Recommended Names	Ticker	Market / Domicile	Benchmark Index	Role in Portfolio
GF China Securities All-Share Information Technology ETF	159939.SZ	Shenzhen Stock Exchange	CSI All-Share Information Technology Index	Hardware earnings realisation
Hang Seng TECH ETF	3067.HK	Hong Kong Stock Exchange	Hang Seng TECH Index	Platform monetisation
T. Rowe Price Funds SICAV – China Evolution Equity Fund	LU2187417386	Luxembourg (UCITS)	MSCI China All Shares Index	Physical infrastructure

Source: Public disclosures from fund managers and index providers; compiled by iFAST Research

This positioning reflects a medium- to long-term investment view. We believe today's AI infrastructure investment will gradually convert into earnings growth over the next two to three years. Consequently, near-term market volatility should not distract investors from the structural opportunity or prompt changes to the underlying portfolio allocation. Each of the three strategies provides exposure to a different but complementary layer of China's AI value chain, enabling investors to calibrate their allocations based on their risk tolerance, investment horizon and preference for passive or active management.

Related Articles

《China's AI hardware opportunity: Global compute boom meets accelerating domestic substitution》

《Market Update: 1Q GDP at 5.0%, Confirming China’s Structural Resilience》

《AI Inflection point meets policy tailwinds: Capturing Chinese technology beta》

《China 2026 Two Sessions: Unlocking policy signals and investment goldmines》

Risk Factors

▪    AI commercialisation and Tao's Law industrialisation falling short of expectations (highest sensitivity): If AI application adoption or the industrialisation of Tao's Law proceeds more slowly than expected, this would directly affect sector earnings delivery. Supply-side momentum is also currently running well ahead of demand, so a slowdown in global AI capex could reverse the direction of the current supply-demand gap.

▪    Geopolitics and export controls: Further expansion of US chip export controls on China, or an intensifying structural shortage of core components, could weigh on earnings for hardware constituent stocks. Persistently high oil prices feeding through into CPI could also constrain policy room in the other direction.

▪    Domestic demand recovery falling short and high single-sector volatility: If consumption-boosting policies transmit more slowly than expected, or the property adjustment cycle extends further, the pace of offshore platform earnings recovery could lag. The recommended vehicles are also heavily concentrated in the single information-technology sector, with volatility and drawdowns significantly higher than broad-based indices — position sizing should reflect individual risk tolerance.

Disclaimer

Important Notice

This report was prepared by the iFAST China Research Team and is intended for general informational reference only; it is published openly for general investors. This report does not constitute, and should not be construed as, an offer, solicitation, or investment advice to buy or sell any security, fund, or investment product, and does not take into account the investment objectives, financial situation, or specific needs of any particular recipient.

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Analyst Disclosure

As at the date of publication of this report, the author, Ian Li, CFA, and his immediate family hold NIL positions or interests in the securities or related investment products discussed in this report; the author's compensation is not directly linked to the specific views expressed in this report.

AI Usage Disclosure

AI-assisted tools may have been used in the drafting, data compilation, and chart-preparation stages of this report; all related outputs have been independently r