Investor confidence in China's earnings growth remains the missing ingredient for a sustained stock market rally in the world's second-largest economy, already battered by government stimulus and overhanging US tensions. “For Chinese stocks to deliver meaningful outperformance, we need to see the policy announcements result in a real easing of deflationary pressures and a recovery in corporate profits, both of which will take time,” said Aaron Costello, head of Asia at Cambridge Associates. An email on Thursday. The CSI 300 index fell 1% last week and fell 2.4% on Friday alone, after Beijing reaffirmed plans to widen the deficit next year and expand economic support, but did not reveal details. China normally announces its GDP target and budget plans at a parliamentary meeting in March. Shares are now nearly 12% below the 52-week high reached in early October. “It is clear that China is setting the stage to increase stimulus in 2025, possibly to counter any unfavorable trade policies from the new Trump administration,” Costello said. Cambridge Associates is neutral on Chinese equities and wants to see more evidence of a recovery in growth. Improving profits Despite the broad pressure on the economy, profits are expected to improve in specific sectors. Chinese medical device companies could see profits rise next year, especially after the Treasury Department earlier this month laid out a draft of plans that would make it 20% cheaper for local governments to buy domestically produced products than foreign ones, they said HSBC analysts in a December report. 10 report. Although the public comment period closes in early January, implementation is unclear. “With the recovery of Chinese hospital medical equipment purchasing from September, we expect a growth recovery for China's medical equipment sector in 2025,” the HSBC analysts said. Shanghai-traded United Imaging could see profits grow 46% in 2025, recouping this year's losses, they predict. Snibe, which trades on the Shenzhen market, could see earnings growth of 19%, while Mindray's earnings are expected to rise 15%. HSBC rates all three stocks as buy. The new policy favoring domestic brands underlines China's desire to reduce its dependence on exports to the US and American high-tech products. The Biden administration has banned Chinese companies from buying advanced semiconductors made in the US, while newly elected President Donald Trump has promised 10% tariffs across the board on Chinese imports. But the exact nature of the next administration's policy toward China is unclear. After ringing the opening bell at the New York Stock Exchange on Thursday, Trump also told CNBC's Jim Cramer that “we're going to have a lot of conversations with China. We have a good relationship with China.” Trump called his previous stance on China overly harsh while noting how talks with Chinese President Xi Jinping could help ease American concerns. On Thursday, Trump's incoming press secretary Karoline Leavitt told Fox News that the newly elected president had invited Xi to the inauguration on January 20. Beijing has not yet responded publicly. Limited upside The upside for the MSCI China Index is limited until foreign investors know the extent of Trump's tariffs and sanctions and see earnings growth across the Chinese economy, the Macro Research Board said in a note on Wednesday. For now, foreign investors are only interested in trading around potential Chinese policy shifts, but are ignoring improving fundamentals, such as how major internet platform companies see a “significant” improvement in future profits, the report said. 'The most important signal for upgrading positions in Chinese shares [from neutral] will be found in an improvement in bank profits,” the MRB report said, noting that “the single most important indicator for China's upgrade would therefore be a rebound in credit volumes.” Credit data for November released on Friday missed economists' expectations, which Reuters and Citigroup analysts pointed out that lower business demand was largely responsible for November's retail sales, industrial production and investment data. 'As much as Beijing wants to stimulate more employment, home purchases and consumer spending. [policymakers] also want to avoid encouraging highly indebted sectors to take on even more debt,” Paul Christopher, head of global investment strategy at the Wells Fargo Investment Institute, said in an email. “This dilemma will likely mean more limited support than in the past. “2024 is a good example of what we think is coming,” Christopher said, referring to the way Chinese stocks have risen in value this year as forecasts for policy support rose and fell. Looking ahead to next year, Christopher said he still favors major U.S. stocks. cap stocks over other assets These include smaller U.S. stocks and names listed abroad, he said, noting that Wells Fargo would use “any increase in emerging market stocks to move into U.S. large-cap stocks in 2024 caps.” on pace for the second consecutive gain of more than 20%. By contrast, this year's rally in Chinese stocks could end several years of declines and a four-year losing streak, with a year-to-date gain of more than 17%. The Shanghai composite is up 14% this year, after two straight years of losses. The MSCI China Index, which tracks stocks traded in both Hong Kong and the mainland, has retained more than half of its gains since surging more than 35% from September lows to October highs. Costello of Cambridge Associates pointed out in a 2025 outlook that a “market collapse is unlikely.” “Downside risks for China appear limited as monetary easing and measures taken to control local government debt risks should help prevent further stress,” Costello said. — CNBC's Michael Bloom contributed to this report.