China's Plan to Fix Stock Market Returns (Worth Buying?)

Last week, MSCI proposed kicking Indonesia out of its Emerging Markets index.

If the proposal goes through, institutions will be forced to sell their Indonesian exposure, and billions of dollars will start looking for a new home in the Asian equity market.

So, which markets will be the next replacement?

Historically, it has been Chinese internet and A-shares, with the likes of:

However,

With the AI boom, that money has chosen a different market to head into.

Taiwan and Korea are taking more than half of that money now.

To be honest, it makes sense, those markets hold close to 75% of their exposure in AI-related plays at the moment, and that’s where every investor wants to be in through managed funds like these.

Just think about some of the biggest players:

And to add fuel to the fire…

Those markets are mostly driven by retail trading activity, highly leveraged at that.

You only need to look at how the KOSPI (South Korea’s index) has performed during the recent bouts of AI volatility, it goes to show just how leveraged and exposed the average population is to the stock market.

Click here to see how this setup has affected South Korean and American memory stocks.

Why should you care?

Because the AI boom looks to be coming to an end, or at least approaching a very late-stage phase of market euphoria and risk-taking.

All with financials from Anthropic and OpenAI showing you trillions of dollars’ worth of AI debt will likely go unpaid and default.

That’s the reason why CoreWeave’s debt is now pricing in a 60% chance of default, why Oracle is in the gutter, and why fear is starting to spread.

With the removal of AI from the Asian flows mix, I believe Chinese internet and A-shares stocks will come back to dominate the MSCI share of ETF flows.

Just like they did before the AI boom took off.

But,

China has a major problem,,,

A problem that has made it one of the worst places to invest in during the past decade (the MCHI ETF has gone nowhere.)

Today, I will show you what that problem is.

More importantly,

How China’s economy is already showing the benefits of fixing it.

Once that becomes clear to the world, it will be too late to buy China’s best and biggest companies.

Let’s get into it,

China’s plan to fix stock market returns (worth buying?)

A big ETF flow shift took place in July of this year.

China’s MCHI ETF started to command more positive flows for the first time since the great financial crisis, all while flows were heading out of South Korea.

Meaning,

While select global funds were buying Korea and selling China throughout 2024 and 2025, that script has been flipped on its head where now funds are selling Korea to buy China.

If that is not a timing coincidence to when the AI financials and data center debt defaults started, I don’t know what is.

This is one of the reasons why I believe China will see a lot more ETF inflows in the coming months (potentially years) as the AI trade continues to unwind, or at least that eventual unwind will act as a catalyst for the Chinese rotation.

But,

To understand that rotation, we must first understand a few things:

Digging into these questions will result in finding the companies most likely to deliver outsized returns in the following years.

Where a proper China portfolio can be built for you to implement inside Offside Premium.

My investment process leans a lot on the capital cycle and expectations as you know by now.

And, as you can tell from this simple chart above:

I want you to pull up a chart of the S&P 500 during those time periods and notice how a rise in spending turns into equity underperformance.

The reason is simple,

When countries invest aggressively, the cost of that capital outpaces the return this capital can earn, no matter if it’s invested in the internet, housing, or AI.

Conversely, when investment intensity decreases, it creates new bull markets.

China has gotten one thing wrong for over two decades now:

If it wasn’t for COVID, when the S&P 500 crashed and emerging markets rallied, China’s stock market would be in the gutter right now.

Here’s why:

Most of those investments in China have gone toward excess infrastructure and property capacity.

When they overshot capacity, utilization rates fell and so did returns for manufacturing companies.

Wait, but isn’t China a manufacturing and net exporting nation?

Yes, but that doesn’t mean they are immune to the laws of the capital cycle.

That’s why they only make ~$0.51 per every $1.00 they invest, while similar nations like Korea and Japan make ~$0.74 and ~$0.88 respectively.

Throughout history, and 42 markets studied, this law stands strong.

Nations that invest in the bottom 18-21% percentile of GDP tend to perform above 7% in their equity indexes.

Anything above that becomes a losing battle.

China’s 40% intensity places it at a mere 3.7% expected return for its stock market.

Even though its companies earn twice the returns on invested capital (ROIC) and trade at 50% discounts compared to American peers.

Fixing that capital trend can potentially fix China’s future equity returns.

Year-to-date, China stands out among the performance and valuation outliers where:

Now here’s a big difference we need to understand…

China’s lower AI exposure is being read as less investment, as the country has spent 10% on AI compared to the U.S. and other Asian countries like Taiwan and Korea.

Yet,

It now holds ~45% of the AI market in terms of token volumes and revenue.

Click here to read why even U.S. tech firms are moving their business to Chinese AI.

The performance and valuation discount, then, can be credited to the macro forces keeping China as a sleeping beast.

In other words, its capital cycle.

At the industry level, Chinese firms in technology have already begun fixing this issue.

Internet and AI companies have more than halved their capital intensity since 2023, except for:

These are choosing to invest heavily into data centers to roll out today’s leading AI models, which have successfully grabbed 45% of the global market share and are already showing profits way ahead of U.S. models.

Outside of the big three though,

You can see how relative stock performance benefits those who decreased their spending intensity the most.

Now let’s take this trend and zoom out to check the country level:

Whenever countries begin to invest below their historical intensity tend to outperform peers over the next five years.

Narrow this down to:

Combined with the fact that emerging markets, mainly China, outperform during periods of S&P 500 drawdowns and volatility.

You begin to get sort of the perfect mix to justify adding more exposure to Asia’s powerhouse.

Now comes the big bang.

Total factor productivity (TFP) measures how productive each person is on average within a country.

China is not only 1.8x more productive than the United States, it also counts with roughly three times as many people adding to this factor.

Meaning,

Trillions of dollars’ worth of corporate profits will unlock once the capital cycle fixes itself, a trend that is already beginning to correct as you read this.

Where have we seen this before?

While the United States was crashing during the internet bubble burst, South Korea was the best place to be invested.

Again, emerging markets tend to rally when the S&P 500 goes into a bear market.

But,

The main reason why Korea was the best choice was its capital investment cycle!

Going from 40% in 1992 to less than 32% in the early 2000s resulted in nearly 600% of total returns, outperforming most peers and the S&P 500 while at it.

That is our best analog for China.

40% capital intensity, depressed stock market, leading total factor productivity.

Because the trend continues to accelerate, and prove that China’s capital cycle could be about to unlock 5-10 years of potential outperformance…

Mainland funds, along with some international investors, have begun buying Chinese equities over the past quarter.

Their top buys include names like:

I suspect this will continue to accelerate as new money gets fed first into the blue-chip large-cap technology firms of China.

That suspicion has now turned into a fact:

Over the past quarter, institutions have been net buyers of Chinese stocks.

All while short interest coverage increases to wipe out the bears who thought China would continue on a downward spiral.

Among the best names, it seems the signal is now centered around internet and consumer companies.

Which is exactly what you can take away from all this, build a watchlist, and track these stocks throughout the rest of 2026.

Offside Premium members, however, will receive my deep dives on the Chinese stocks I’m personally looking to buy here.

Stay tuned for that.

The options flow has flagged a recent shift in shares of Alibaba (BABA) and where the big participants expect it to go next.

For January 2027, the bet is for the stock to reach $160 or so:

60,000 call options for that price have been opened as the biggest outlier in sentiment right now.

The better part?

There’s a massive “call wall” now placed at $120 after our last trade at the $110 call wall was taken out at a hefty profit.

Running into January, there are lots of catalysts for this view to be proven correct, most importantly the rotation out of U.S. AI exposure as a de-risking event in the broader S&P 500 index.

As you now know…

Emerging markets tend to outperform when the S&P 500 goes into bear markets, and China specifically is set to receive all the flows heading out of Korea and Taiwan if that AI rotation becomes global.

Let’s see where the stock can get to before the year is over.

More importantly, I will be watching over some long/short options structures to play this again.

Meanwhile, here is a short documentary on China’s economy and the current way of living there.

Even though this is a bit older, it goes to show you just how challenging it has become to make sense as to why China’s stock market isn’t growing as much.

Today, you’ve learned why that is and its fix, this video shows you how well positioned China really is:

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.