Finance
China’s deflationary slide worsens as companies spiral into price wars
The urban skyline and cityscape in Shanghai China.
Lu Shaoji | Moment | Getty Images
BEIJING — From coffee to cars to real estate, there’s a recurring pattern in China: companies rush into an industry, then resort to discounts to stay afloat. That has economists worried.
Natixis’ study of 2,500 listed Chinese companies reinforce how volume is growing while value is being hurt by deflationary pressure, Alicia Garcia Herrero, the firm’s chief economist for Asia-Pacific, said on a webinar Friday. “You can see it sector by sector, company by company.”
“On the surface you’re dominating, but deep inside you’re paying a high price to dominate,” she said. “You don’t get the revenue needed to continue.”
A reflection of the breadth of impact, consumer prices fell by 0.1% in the first six months of the year from a year ago, while factory-gate producer prices dropped by 2.8%, official data shows. In that time, only seven of 48 producer price sub-categories rose, versus about half of the 37 consumer price components.
That fierce and often unproductive competition is described as “involution” in China. The government has picked up on the term in recent policy documents, calling for efforts to tackle the trend.
While the trend has made tech and products more affordable for the mass market, it has also underscored worries of a vicious cycle that forces businesses to cut more jobs.
“With involution, the Chinese economy feels much colder than the headline growth suggests,” Larry Hu, chief China economist at Macquarie, said in a report Thursday. He pointed out that mainland China-listed “A share” companies expanded their workforces by just 1% in 2024, the slowest on record.
“From a more fundamental perspective, involution is both a feature and a bug of the ‘China model,'” he said. “Massive investment leads to price wars and poor returns for shareholders. But for policymakers, intense competition could help achieve industrial upgrading and self-reliance.”
China’s push into electric cars has been the most apparent example, with industry giant BYD offering some discounts of nearly 30% or more this year and smartphone company Xiaomi pricing its latest SUV below that of Tesla’s Model Y.
U.S. coffee giant Starbucks has struggled in China with falling sales as it maintains prices of around 30 yuan per cup ($4.20) — while a host of rivals from Luckin Coffee to boutiques sell lattes for as low as 9.9 yuan.
Even in commercial real estate, property owners who have tried to raise prices in Beijing ended up facing higher vacancies, Rayman Zhang, managing director for North China, at property manager JLL, told reporters Thursday. He noted that there’s still insufficient demand — with little expectation for a turnaround in the near future.
China is expected Tuesday to report second-quarter gross domestic product growth of 5.2% from a year ago, according to a Reuters poll. That would be slower than the 5.4% increase in the first quarter, but in line with the national target of around 5% growth for the year.
But the second half of the year will likely reveal a far more stressful picture, warned Jianwei Xu, senior economist for Greater China at Natixis. He was also speaking at Friday’s webinar.
“We are seeing the profits especially for manufacturing companies, are still decreasing,” he said. “There could be more households under stress in [the second half of the year] because it will be more difficult to find a job.”
A different challenge
This isn’t the first time China has dealt with overcapacity, analysts pointed out, referencing excessive capacity in the state-dominated commodities sector about a decade ago. But this time, fewer state-owned companies are involved, making it more difficult for policymakers to act.
“The dominance of private firms in industries with overcapacity tends to complicate the coordination of mergers, even with government guidance,” Robin Xing, chief China economist at Morgan Stanley, and a team said in a report Thursday.
“The economy is also starting from a weaker point, which necessitates more demand-side stimulus to counter the impact of supply reduction,” the report said. “However, the government’s debt level is already high (~100% of GDP), which may constrain its willingness and ability to undertake aggressive fiscal expansion.”
China’s top leaders are expected to maintain the current fiscal stimulus at a high-level Politburo meeting late this month. Beijing in March raised the country’s fiscal deficit for the year to 4% — up from 3% last year.
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Notably, Chinese President Xi Jinping on July 1 led a high-level financial and economic commission meeting that called for more governance of “low price, disorderly competition,” according to a CNBC translation of Chinese state media.
The ruling Chinese Communist Party’s official Qiushi journal on July 1 even outlined several measures that promote standardized government behavior to address involution-style competition, warning of serious economic damage. The article cited high-level government meetings from the last several months.
“To achieve the growth target, Beijing will have no choice but to launch a major demand stimulus,” Hu said. “Afterwards, the improved domestic demand would ease the price competition among material producers and internet giants. But for manufacturers, it will be a long and painful process to absorb the existing capacity.”
Global spillover
Exacerbating problems with resolving China’s domestic overcapacity is the trade war with the U.S., Goldman Sachs analysts pointed out in a July 1 report.
The U.S. and European Union became more critical of China’s persistent overcapacity issues last year. Both have raised tariffs on Chinese electric cars in particular in an attempt to protect domestic automakers. The U.S. in April also targeted China with higher duties across the board.
The escalation of tariffs has made Chinese manufacturers more determined to build factories overseas, “potentially generating redundant supply in the coming years,” the Goldman report said. The analysts estimated a 0.5% to 14% increase in capacity by the end of 2028, up from the 0.4% to 10% expansion projected a year ago.
And among seven sectors — air conditioners, solar modules, lithium batteries, electric vehicles, power semiconductors, steel and construction machinery — five have more capacity than the entire global demand, the Goldman analysts said. Only ACs, and EVs — just barely — enjoy some market potential.
— CNBC’s Victoria Yeo contributed to this report.
Cybersecurity and enterprise software stocks have been market dogs in 2026, with fears that AI will wipe out a wide range of companies in the enterprise space dominating the narrative. But they snapped a brutal losing streak this past week, joining in the broader market rally that saw all losses from the U.S.-Iran war regained by the Dow Jones Industrial Average and S&P 500.
Cybersecurity has been “a victim of some of the AI-related headlines,” Christian Magoon, Amplify ETFs CEO, said on this week’s “ETF Edge.”
It wasn’t just niche cybersecurity names. Take Microsoft, for example, which was recently down close to 20% for the year. Its shares surged last week by 13%.
A big driver of the pummeling in software stocks was a rotation within tech by investors to AI infrastructure and semiconductors and some other names in large-cap tech, Magoon said, and since cybersecurity stocks and ETFs are heavily weighted towards software companies, they were left behind even as those businesses continue to grow on a fundamental basis.
But Wall Street now has become more bullish with the stocks at lower levels. Brent Thill, Jefferies tech analyst, said last week that the worst may be over for software stocks. “I think that this concept that software is dead, and then Anthropic and OpenAI are going to kill the entire industry, is just over-exaggerated,” he said on CNBC’s “Money Movers” on Wednesday.
“Big Short” investor Michael Burry wrote in a Substack post on Wednesday that he is becoming bullish about software stocks after the recent selloff. “Software stocks remain interesting because of accelerated extreme declines last week arising from a reflexive positive feedback loop between falling software stocks and changes in the market for their bank debt,” he wrote.
The Global X Cybersecurity ETF (BUG), is down about 12% since the beginning of the year, with top holdings including Palo Alto Networks, Fortinet, Akamai Technologies and CrowdStrike. But BUG was up 12% last week. The First Trust NASDAQ Cybersecurity ETF (CIBR) is down 6% for the year, but up 9% in the past week.
Piper Sandler analyst Rob Owens reiterated an “overweight” rating on Palo Alto Networks which helped the stock pop 7% — it is now down roughly 6% on the year. Its peers saw similar moves, including CrowdStrike.
Performance of Global X cybersecurity ETF versus S&P 500 over past one-year period.
Magoon said expectations may have become too high in cybersecurity, and with a crowding effect among investors, solid results were not enough to to push stocks higher. But the down-and-then-back-up 2026 for the sector is also a reminder that when stocks fall sharply in a short period of time, opportunity may knock.
“Once you’re down over 10% in some of these subsectors, you start to see the contrarians start to say, ‘well, maybe I’ll take a look at this,'” Magoon said.
He said AI does add both opportunity and uncertainty to the cybersecurity equation, increasing demand but also introducing new competition. But he added, “I think the dip is good to buy in an AI-driven world,” specifically because the risks to companies may lead to more M&A in cyber names that benefits the stocks.
For now, investors may look for opportunity on the margins rather than rush back into beaten-up tech names. “I think investors are still going to remain underweight software,” Thill said.
But Magoon advises investors to at least take the reminder to keep an eye on niches in the market during pronounced downturns. “The best-performing are often the least bought and do the best over the next 12 months versus late-in-the-game piling on,” he said.
While that may have been a mindset that worked against the last investors into cybersecurity and enterprise software in mid-2025 when the negative sentiment started building, at least for now, it’s started working for the stocks in the sector again.
Meanwhile, this year’s biggest winner is also a good example of what can be an extended trade in either a bullish or bearish direction. Last year, institutional ownership of energy was at multi-year lows, Magoon said, referencing Bank of America data. “Reverse sentiment can be a great indicator,” he said.
But he cautioned that any selective buying of stocks that have dipped does have to contend with the risk that there is a potentially bigger drawdown in the market yet to come in 2026. That is because midterm election years historically have been marked by large drawdowns. “If you think it is bad right now, it could get a lot worse,” Magoon said. But he added that there’s a silver-lining in that data, too, for the patient investor. The market has posted very strong 12-month returns after midterm election drawdowns end. So, for investors with a longer-term time horizon and no need for short-term liquidity, Magoon said, “stick in there.”
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New innovation in the exchange-traded fund industry could come at a cost to investors during extreme conditions.
According to MFS Investment Management’s Jamie Harrison, ETFs involved in increasingly complex derivatives and less transparent markets may be in uncharted territory when it comes to violent downturns.
“Those would be something that you’d want to keep an eye on as volatility ramps up,” the firm’s head of ETF capital markets told CNBC’s “ETF Edge” this week. “As innovation continues to increase at a rapid pace within the ETF wrapper, [it’s] definitely something that we advise our clients to be really front-footed about… Lack of transparency could absolutely be an issue if we’re going to start seeing some deep sell-offs.”
His firm has been around since 1924 and is known for inventing the open-end mutual fund. Last year, ETF.com named MFS Investment Management as the best new ETF issuer.
“It’s important to do due diligence on the portfolio,” he said. “Having a firm that has deep partnerships, deep bench of subject matter experts that plays with the A-team in terms of the Street and liquidity providers available [are] super important.”
Liquidity as the real issue?
Harrison suggested the real issue is liquidity, particularly during a steep sell-off.
“We’ve all seen the news and the headlines around potential private credit ETFs. That picture becomes much more murky,” he added. “It’s up to advisors, to investors [and] to clients to really dig in and look under the hood and engage with their issuers.”
He noted investors will have to ask some tough questions.
“What does this look like in a 20% drawdown? How does this liquidity facility work? Am I going to be able to get in? Am I going to be able to get out? And if I’m able to get out, am I able to get out at a price that’s tight to NAV [net asset value], and what’s the infrastructure at your shop in terms of managing that consideration for me,” said Harrison.
Amplify ETFs’ Christian Magoon is also concerned about these newer ETF strategies could weather a monster drawdown. He listed private credit as a red flag.
“If your ETF owns private credit, I think it’s worth taking a look at, kind of what the standards are around liquidity and how that ETF is trading, because that should be a bit of a mismatch between the trading pace of ETFs and the underlying asset,” the firm’s CEO said in the same interview.
Magoon also highlighted potential issues surrounding equity-linked notes. The notes provide fixed income security while offering potentially higher returns linked to stocks or equity indexes.
“Those could potentially be in stress due to redemptions and the underlying credit risk. That’s another kind of unique derivative,” Magoon said. “I would very closely look at any ETF that has equity-linked notes should we get into a major drawdown or there be a contagion in private credit or something related to the banking system.”
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