Chinese equities face another volatile year as policy clouds gather at home and abroad

Unprecedented efforts by China to revive growth lit a fire under markets in late September, lifting depressed sentiment toward Chinese equities. In just six trading days in early October, the benchmark Shanghai Composite Index jumped to the highest level since February 2022.

That sparked hope of a Chinese equities comeback, but waves of subsequent stimulus have met with disappointment and selloffs.

Simmering U.S.-China tensions have added to the risk-off mood. Now that Donald Trump’s re-election has crystallized the risk of another trade war, the potent mix of uncertainty is dimming the outlook for Chinese equities.

“Markets don’t like uncertainty. This is a mountain of uncertainty that China faces," said Michael Kelly, global head of multiasset at PineBridge Investments.

Investment manager Nuveen had turned slightly more bullish on Chinese equities on the back of earlier stimulus, said Laura Cooper, head of macro credit.

“But when we overlay that with the tariff uncertainty now, we’ve tempered that perspective," the global investment strategist said.

Chinese officials’ recent stimulus efforts have failed to impress, with the latest centering on local government debt and skirting other core issues. That could be in part because Beijing is saving its ammunition for another trade war.

If China announces the “big-bang" stimulus markets want, that could well spark another run higher. But there are concerns that it will be too little too late.

“At this juncture, we’re focusing on how much and how quickly they can come up with the stimulus," Nuveen’s Cooper said. She sees a risk Beijing could wait until the first quarter of next year, when there is more clarity from the U.S. “To our mind that’s probably too delayed."

Economists at Morgan Stanley see limited chance that China will front-load enough fiscal stimulus to target consumption and housing in 2025, due in part to worries about setting a precedent where welfare statelike aid will be expected.

U.S. tariff hikes and a potential broadening of other restrictions against China could generate even stronger headwinds to corporate earnings and market valuations, they said in a report.

Until more clarity emerges, portfolio managers recommend looking at Chinese companies that rely on strong domestic demand, have solid fundamentals and are less reliant on exports.

For now, no one sector seems set to gain from the last round of stimulus, Daiwa equity strategist Patrick Pan said. In the short term, he sees both Hong Kong and mainland Chinese markets pulling back.

But as China looks to pivot its economy to domestic demand instead of exports, makers of consumer products like home appliances or providers of services like travel look like good long-term plays, Pan added.

Onshore retail investors might also find opportunities that are more domestically oriented, Homin Lee at Lombard Odier said, especially in sectors China deems strategically important like electric vehicles or among “little giants," referring to small- and medium-size enterprises that own core technologies.

From the perspective of foreign investors, the best route is to focus on relatively well-managed names in the Hong Kong or offshore market, said Lee, senior macro strategist at the wealth and asset manager.

These sorts of stocks are highly sensitive to the Chinese economy, and tend to be cheaper, he said. Well-known names in the consumer discretionary, technology, media, and telecom space may hold promise, “if you can be slightly more aggressive," he said.

There’s a sense among economists that delayed or not, Beijing will provide more oomph to its economy. With stock valuations cheap, there’s opportunity to be found.

Goldman Sachs strategists said that recent meetings with policymakers in Beijing suggest support can and will be increased to counteract growth risks and to bolster the equity market. In a report, they said they continue to favor the domestic A-share market in part due to equity funding measures rolled out by officials.

Hong Kong’s valuations aren’t demanding but don’t offer much in the way of economic or earnings growth potential. “We prefer to focus on China directly," GS said.

For those who want to brave the waters, stocks that are more insulated from trade shocks, have a firm base in China and convincing fundamentals offer openings to position for an eventual revival, particularly in the A-share market that is more sensitive to local than foreign policy.

“It can be nice to have China stocks as a diversifying exposure but do you want to make it the most important driver return in your portfolio? It’s very difficult." Lombard Odier’s Lee said.

Write to Jiahui Huang at Jiahui.Huang@wsj.com and Fabiana Negrin Ochoa at fabiana.negrinochoa@wsj.com