China’s defense industry is getting a DeepSeek moment

Shuli Ren, Bloomberg

In investing, narratives can matter a lot more than earnings or cash flow analysis.

Pakistan is certainly spinning a good story about China’s defense industry. Its army said it used Chinese J-10C planes to shoot down five Indian jets, including three Rafales, a MIG-29 and an Su-30. Rafales are made by France’s Dassault Aviation SA, while the other two were imported from Russia. India’s government has not confirmed or denied Islamabad’s claim and evidence remains inconclusive.

Nonetheless, investors got excited. It was the first real combat between modern Chinese warplanes and advanced Western jets — and surprisingly, China seems to have come out on top. On Monday, Avic Chengdu Aircraft Co., which made the J-10C jets, soared 20.6%, while Dassault tumbled 6.2%.

Some are hailing it as another DeepSeek moment for China. In late January, a little-known Hangzhou-based startup released an AI reasoning model that performed almost as well as OpenAI at a fraction of the cost, thereby propelling a bull run in Chinese tech names. Are we witnessing a repeat, in defense this time?

I see parallels. While the jury is still out on how disruptive DeepSeek is to US big tech, its arrival has pointed to a new way forward for China, and shows that growth is still possible despite President Donald Trump’s tariffs. More than manufacturing electronics and apparel, Chinese companies can be good at making software, too, the thinking goes. Over time, they might just be able to gain market share in services exports, which the US dominates.

Similarly, Chinese defense companies might one day be able to sell more weapons overseas. Between 2020 and 2024, China accounted for only 5.9% of global arms exports, well behind America’s 43%, according to the Stockholm International Peace Research Institute. In addition, there’s little geographical diversity; Almost two-thirds of China’s weapons exports went to Pakistan.

So imagine China selling more warplanes and missiles to the Global South. Already, it’s the biggest supplier in West Africa, accounting for 26% of total arms imports there. This is lucrative business: Dassault Aviation notched 17% net income margin last year.

To be sure, investors will have to wait for months, if not years, to see if developing nations friendly with Beijing will place more military equipment orders. But positioning well ahead of positive earnings is nothing new. German and French defense names are on fire this year, triggered by the White House’s isolationist foreign policies and NATO countries’ vows to ramp up spending. Whether the Europeans can get their act together is another matter. But that has not stopped Dassault from rallying more than 50% for the year despite Monday’s drop. Meanwhile, Germany’s Rheinmetall AG and Hensoldt AG more than doubled in market value.

There is also the lack of availability. One reason European military stocks are doing so well is because there are only a handful of publicly listed names that asset managers can get exposure to. After all, for decades Europe relied on the US for national security, so the continent’s defense industry is fragmented and in need of an overhaul. A similar picture emerged in China. Military modernization is new and the country only weaned itself off imported Russian weapons in the mid-2010s.

For arms exporters, there’s no better advertisement success in a real confrontation. In a way, China’s long-held friendship with Pakistan is already paying off. Islamabad is doing a great job marketing Beijing’s military might.