China's Stock Rally Stalls as Weak Earnings Loom in 2026

Introduction: A Rally on Shaky Ground

A prolonged bull run in Chinese equities is showing signs of strain as investors confront a challenging reality: corporate earnings are failing to keep pace with market optimism. After a surge in 2025 driven largely by recovering confidence, the market's next move in 2026 hinges on tangible profit growth. However, a wave of negative earnings pre-announcements for the fourth quarter of 2025, coupled with slowing economic indicators, is casting a shadow over the market's sustainability and fueling investor caution ahead of the Lunar New Year holiday.

The Deteriorating Earnings Picture

Corporate profit forecasts for the final quarter of 2025 paint a concerning picture. An analysis by Morgan Stanley of over 2,000 mainland-listed A-share companies reveals a significant downturn. Negative earnings alerts now outnumber positive ones by a margin of 14.8%, a stark contrast to the net negative figure of 4.8% recorded in the second quarter. This trend is particularly pronounced among smaller firms and those in the real estate and consumer-focused sectors, which continue to grapple with weak domestic demand.

This earnings weakness reflects a broader economic slowdown. China's GDP growth cooled to 4.5% in the last quarter, its weakest performance since the country emerged from Covid lockdowns in late 2022. The economic strain is further evidenced by persistent deflationary pressures. Producer prices fell 1.4% in January from a year earlier, extending a streak that began in late 2022 and continues to erode corporate pricing power and profit margins.

Economic Headwinds and Market Disconnect

The disconnect between the stock market's performance and underlying economic fundamentals is becoming more apparent. While Chinese stocks rallied in 2025, their momentum has slowed in the new year. The MSCI China Index has risen just 0.8% year-to-date, significantly underperforming the MSCI All World Index's 2.8% gain. The gap is even wider when compared to regional peers, with South Korea's primary index surging 31% and Taiwan's jumping 16%.

Analysts suggest the rally has been fueled more by a lack of alternative investment options for cash-rich investors than by strong fundamentals. This has led to warnings of "irrational exuberance" and a standoff between market bulls and macroeconomic bears. The recent slowdown in manufacturing and non-manufacturing PMIs underscores insufficient underlying demand, a problem exacerbated by the scaling back of government stimulus programs.

A Market of Contrasts: Sector Divergence

While the overall market outlook is cautious, performance is diverging sharply across industries. Certain sectors are thriving despite the broader economic challenges. Metal miners, for instance, are benefiting from a surge in commodity prices. CMOC Group Ltd. announced that its preliminary full-year net income jumped by approximately 50%. Similarly, companies in the artificial intelligence supply chain are seeing strong gains, with software maker Iflytek Co. reporting a profit increase of between 40% and 70%.

In contrast, sectors heavily reliant on consumer spending are struggling. Electric-vehicle manufacturers like BYD Co. and Great Wall Motor Co. saw their shares slump following disappointing January sales figures. This divergence complicates stock selection and highlights the uneven nature of China's economic landscape.

Key Financial Metrics Summary

Regulatory Caution and Historical Echoes

Adding to investor uncertainty is increased regulatory intervention. Last month, Chinese authorities tightened margin financing rules to curb speculative trading and mitigate the risk of a boom-and-bust cycle. This move, combined with the weak economic data, has made investors hesitant to take on new risks, particularly before the long holiday period.

The current situation has drawn comparisons to the market meltdown of 2015, when a retail-led frenzy during an economic slowdown ended in a sharp correction. However, analysts note key differences this time. The current rally has been slower and has seen broader participation from institutional investors, which could provide a more stable foundation. Nonetheless, the memory of 2015 serves as a cautionary tale.

The Outlook for 2026

Looking ahead, the consensus is that for the bull run to continue, the driver must shift from valuation expansion to genuine earnings growth. Projections for 2026 are cautiously optimistic. UBS Group forecasts that profit growth for Chinese companies will accelerate to 8% from 6% in 2025, while JPMorgan Chase anticipates growth in the range of 9% to 15%. These forecasts depend on faster nominal economic expansion and an easing of producer-price deflation.

Achieving this will require tangible improvements in corporate profitability. The market will be closely watching for major policy announcements, though none are expected before the National People’s Congress convenes in March. The coming months will be a critical test of whether China's corporate sector can deliver the profits needed to justify current market valuations.

Conclusion

The confidence that propelled Chinese stocks in 2025 is now being tested by hard economic numbers. The sustainability of the market rally is fundamentally in question, with weak corporate earnings and a slowing economy acting as significant headwinds. While some sectors show resilience, the broader market requires a fundamental improvement in profitability to advance further. Investors are now watching to see if supportive policies and cyclical factors can translate into the strong earnings growth needed to reignite the bull run in 2026.