CNBC's The China Connection newsletter: Waiting for AI to lift the whole market

Hi, this is Evelyn, writing to you from Beijing. Welcome to the latest edition of The China Connection — a snapshot of what I'm seeing and hearing from local businesses.

As AI captures more and more headlines, what are they missing about the rest of the economy?

Since the pandemic, the China story has diverged as tech advances grab attention, while traditional industries fade.

Now that's showing up in official economic data. Artificial intelligence-related chip demand is driving exports and some inflation. But the real estate slump has worsened, while consumers still aren't spending that much.

As investors await retail sales and investment figures for May, due out at 10 a.m. local time Tuesday, Standard Bank's Jeremy Stevens asks when the GDP downgrades will start.

"We don't see a credible path to 4.6% in Q2:26," he said in a note Wednesday. "Instead, a test of the 4% threshold in Q2:26 seems the natural landing zone."

"The Iran war has smashed manufacturing margins already squeezed to five-year lows, dented consumer confidence, and fortified arguments favoring precautionary cash-hoarding," he said. Stevens also cautioned about rising pressure on exports due to growing import costs and potentially weaker demand abroad.

China typically reports second-quarter GDP in mid-July, and top leaders assess stimulus plans at a meeting later that month.

Economists expect data for May will affirm broad stagnation.

Retail sales eked out a 0.2% gain in April — the slowest since Covid restrictions ended in December 2022 — and are forecast to slow to 0% in May from a year ago, according to a Reuters poll of economists.

Industrial output for May is expected to tick up to 4.3%, from 4.1% in April, the poll showed.

Fixed-asset investment, reported on a year-to-date basis, is forecast to drop by 2% during the first five months of the year. That's steeper than the 1.6% drop for the year as of April, with a real estate investment drag of 13.7%.

"Property remains the single biggest reason we are not more bullish" on China, KKR said in its mid-year outlook published last week. The large amount of unsold homes means it will take China longer than other countries to put the property slump behind it, the report said.

KKR estimates the real estate drag will narrow to 0.6 percentage points next year, from 1 point this year.

In 2027, digitalization will contribute 2.5 percentage points to China's GDP, the report said. But it noted a modest 0.9-point contribution from retail and tourism won't be enough to prevent overall economic growth from slowing to 4.4%, down from 4.6% this year.

It's a tough world for foreign companies to navigate.

General Mills said earlier this month it's selling its Haagen-Dazs stores in mainland China.

Swiss-based sportswear company On, which trades as On Holding, has caught the athletic trend far better than other brands, and a forthcoming store in downtown Beijing is replacing a now-closed Nike location. But Lululemon isn't seeing such strong growth in China that it can offset weakness in North America.

Audi's new brand — aimed at affluent young women with prominent Xiaohongshu ads and Olympic tennis "queen" Zheng Qinwen as a brand representative — sold just 900 cars in China in May, far behind Tesla, according to figures from China AutoHome.

Chinese companies are instead playing a larger role.

Sportswear and equipment company Li-Ning signed NBA star Stephen Curry in a deal that is set to see him develop Curry-branded stores, the firm said earlier this month. Haagen Dazs's new owners include a Chinese tea company, according to General Mills.

The rapidly growing story is that Chinese businesses, and increasingly their tech, are expanding overseas.

Home appliance giant Midea on June 9 announced a new tech solutions product to help Chinese companies manage an international factory network — with AI and automation software.

"Companies in technology, manufacturing, metals, and transport sectors are reporting strong overseas growth, with increasing profit that is often above average," Moody's said in a report last week.

Back in Beijing, the mood has shifted into the summer holidays, as high schoolers completed the annual college entrance exam in early June. Similar to during the depths of the pandemic, people are venturing out on the streets again — not necessarily spending much, but enjoying the best air quality in recent years.

"Once it's summer I'm very active, but in winter I'm rather dispirited," Quan Zhao, who works in the film and entertainment industry, said via a CNBC translation of the Mandarin. He said he'd been out until 4 or 5 a.m. recently. "There are lots of fun places nearby."

Pentagon expands list of China military-linked firms to include Alibaba, Baidu

The U.S. Defense Department included a slew of Chinese companies in an updated list of entities it believes have aided the Chinese military.

Electric vehicle giant BYD predicts 80% of China car sales will soon be electric

Despite a recent slowdown in China's electric car market, BYD's Executive Vice President Stella Li told CNBC's Arjun Kharpal that she expects EV penetration to grow thanks to new tech such as fast-charging.

A Chinese start-up's unfolding dilemma exposes cracks in Beijing's tech funding machine

The rapid succession of events involving Chinese robot vacuum company Dreame underscore Beijing's tough balancing act in trying to rival U.S. tech dominance. While the state pours in money to support China's tech ambitions, there are not always the guardrails and market forces to prevent widespread misallocation.

June 16: Retail sales, industrial production and investment data for May

June 19: Mainland China and Hong Kong stock exchanges closed for holiday

June 22-26: China International Supply Chain Expo (CISCE) is held in Beijing