The Hunt for AI Gains Is Lifting Chinese Stocks. Here's What You Need to Know.

As the U.S. wrestles China for AI dominance, investors are playing both sides.

Chinese stocks have seen a big boost this quarter, extending year-to-date returns amid improving sentiment around the U.S.-China trade talks and higher conviction arounds its capabilities in artificial intelligence. The Shanghai Composite and CSI 300 are up 18% and 20% year-to-date, compared to 13% for the S&P 500, the U.S. benchmark.

Much of the action in China has been driven by Chinese money, but foreign investors are also buying in. Invesco's Golden Dragon ETF (PGJ), which tracks an index of U.S. exchange-listed shares of China-based companies, is up more than 29%, while the Invesco China Technology ETF (CQQQ) is up more than 51% over the same period. Global hedge funds in August logged their strongest month of investment in Chinese companies in six months, according to Morgan Stanley.

Some of the demand may have been driven by investors seeking out ways to play the AI theme at comparatively low prices. The MSCI China Index traded at 12 times projected earnings, compared to the S&P 500's 23 through the end of August.

"If you were not early in the U.S., perhaps there's another way to play this growing AI theme in an area where, from a valuation perspective, they look a little bit more attractive," said Rene Reyna, head of thematic and specialty product strategy at Invesco, in an interview with Investopedia.

The degree of the effect Chinese competition could have in the AI race was illustrated in January when a startup called DeepSeek unveiled a model that appeared to rival OpenAI's and Google's (GOOGL). The news sank domestic AI stocks.

AI plays in the U.S. have since bounced back, but Chinese conglomerates including Alibaba (BABA) and Baidu (BIDU) have leapfrogged them as they revealed in-house development of AI chips and ramped up related spending plans. The ADRs of Alibaba and Baidu have run up more than 100% and 60% so far this year, respectively, compared to Nvidia's 26% gain and Microsoft's (MSFT) 21%.

China's ban on Nvidia chips has fueled concerns that the U.S. had underestimated the country's capabilities and overestimated the efficacy of blocks put in place to keep U.S. tech from reaching its shores. Whether China is "posturing" or means it when they effectively say "We don't need you" to U.S. tech suppliers remains an outstanding question, Reyna said. (That said, Alibaba recently announced a partnership with Nvidia to build out its AI capabilities.)

Appaloosa Management, the hedge fund run by David Tepper, has trimmed its China stock holdings since late 2024 when the veteran investor said it was time to "buy everything" there; the firm has existing positions in Alibaba, JD.com (JD), PD Holdings (PDD), and Baidu, according to a regulatory filing.

Tepper in an interview with CNBC last week said that while market valuations make it difficult to make stock recommendations without caveats, "you've had movement in that market because people are realizing you have the same sort of AI things there" as in the U.S.