The current market rally is fueled by the renminbi's appreciation, which is driving cross-border capital inflows. Even if the AI sector experiences corrections, carbon-based consumption sectors are poised to take over the baton. Physical AI, represented by Google's Robotics 2, has the potential to boost global demand for computing power. However, the primary application scenarios for physical AI lie in China's industrial production sector, making China's cost-effective models and domestic computing power more likely to benefit.
Carbon-Based sectors take over in July, and market profitability remains strong
While the A-share market saw a significant rally in the second quarter, the concentration of funds in the AI sector drained capital from other industries, leading to a contraction in overall market profitability. In July, volatility in tech stocks increased, causing funds to flow back into value-oriented blue chips like consumer staples. Although the market experienced some adjustments, the breadth of profitability actually improved. We believe that the renminbi's appreciation, which drives cross-border capital inflows, is the primary catalyst for this bull market. The current increase in AI volatility does not signal the end of the rally; it merely represents a rebalancing of the "Bull Market Barbell" from an extreme AI-focused rally to cyclical sectors with rising prices.
The DeepSeek 2.0 moment: AI may be entering the "Carbon-Based Era"
(1) DeepSeek's emergence last year, with its extreme cost-efficiency, initially disrupted global demand for computing power. However, the rapid rise in demand driven by multimodal models and Vibe Coding helped the market move past the DeepSeek shock. (2) Currently, cost-effective domestic large models like Kimi K3 are once again challenging global high-end computing power demand. Physical AI, such as Google's Robotics 2, is expected to spur another surge in computing power demand, and the market will ultimately overcome what could be called the "DeepSeek 2.0 Moment." We believe there is no need for excessive concern about the AI industry's trajectory. The core logic of the AI rally is shifting from a competition over model performance to a contest for applications in the physical world. The demand for silicon-based AI computing power must ultimately be grounded in the carbon-based physical world.
Focus on domestic computing power and AI applications during the AI Carbon-Based Era
Clients are likely to pay a premium for North America's high-priced computing power only when U.S. models maintain a generational lead over Chinese models. Currently, China's cost-effective models are challenging North America's high-priced computing power and models. While physical AI could significantly expand global computing power demand, its application scenarios are more prevalent in China's industrial production. Chinese enterprises may find it difficult to integrate North American models into their production processes on a large scale. This means that even if North American physical AI holds a generational lead over China, Chinese companies may not be willing to pay a premium for it. Therefore, the focus of AI investment should shift from the North American computing power chain to the domestic computing power chain and AI application sectors.
The Politburo meeting elevates stabilizing the real estate market to the level of "building a security barrier"
In our July 6 report, "Consumer Bottom, Value Bull Market," we noted that when the external environment deteriorates and export pressures mount, China may need to maintain low factor prices to "protect exports." However, when internal pressures increase or the external environment improves, domestic policy may shift towards "expanding domestic demand" to restore factor prices. Since President Trump's visit to China in May, which established a "constructive strategic and stable relationship," the improved external environment has allowed domestic policy to pivot towards "expanding domestic demand": On June 18, the "Qiushi" journal proposed repairing household balance sheets; on July 13, the "15th Five-Year Plan" for expanding domestic demand was released; and this week, the Politburo meeting elevated stabilizing the real estate market to the level of "building a security barrier." With the improvement in the external environment, the policy direction is clear: to support housing prices and stabilize the real estate market, repair household balance sheets, and further expand domestic demand.
Sector allocation: Focus on real estate/consumer, domestic computing power, and Hong Kong-listed internet
This bull market is driven by the renminbi's appreciation and cross-border capital inflows. AI and pro-cyclical sectors with rising prices represent the two ends of the "Bull Market Barbell." After the extreme concentration of funds in AI during the second quarter, the third quarter will see a rebalancing towards pro-cyclical sectors with rising prices. (1) PPI Chain: The pressure on gold is easing, which may be reflected in A-share non-ferrous metals and drive a rebound. Meanwhile, export-oriented sectors (chemicals/pharmaceuticals) can be used to hedge against weaker-than-expected domestic demand recovery. (2) CPI Chain: The policy window for "expanding domestic demand" is open. If household balance sheets are repaired in the second half of the year, we recommend focusing on consumption reversal opportunities (real estate, baijiu, etc.). (3) AI Chain: The period of high volatility may be in its final stages. The investment focus should shift back from the overseas chain to the domestic chain (domestic computing power / Hong Kong-listed internet).
Market review and outlook
This week, the A-share market, overseas markets, and other major asset classes performed as follows: East Money All A was up 0.50%, the Shanghai Composite Index was up 0.47%, the CSI 300 was down 1.31%, the CSI 500 was down 0.51%, the ChiNext Index was down 3.93%, and the STAR 50 was down 8.46%. Among various market styles, large-cap value was up 2.23%, large-cap growth was down 3.28%, small-cap value was up 3.54%, and small-cap growth was down 0.20%. Among major sectors, consumer discretionary and consumer staples showed the strongest weekly gains, at 5.37% and 4.60%, respectively, while TMT and manufacturing posted the weakest performance, at -5.33% and 1.12%, respectively. Among first-tier industries, the top three gainers for the week were Media, Social Services, and Retail & Trade, with gains of 12.81%, 9.69%, and 8.53%, respectively. The bottom three performers were Telecommunications, Electronics, and Machinery & Equipment, with losses of -10.39%, -8.77%, and -0.80%, respectively. Most overseas markets rose this week, with the S&P 500 gaining 1.05% and the Hang Seng Index rising 3.69%. Commodity prices saw crude oil decline and metals show mixed performance, with Brent crude down 0.70% and COMEX gold up 0.68%. As of the end of this week, the yield on China's 10-year government bond was 1.71%, down 1.41 basis points from the previous week.
Risk factors
Risks include unexpected changes in global macroeconomic data, unexpected changes in geopolitical situations overseas, and changes in the pace of technological progress and application implementation.
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