China's Producer Price Index (PPI) turned positive in March 2026, rising 0.5% year-on-year, marking the end of a 41-month period of consecutive declines and signaling the conclusion of the industrial deflation cycle. This shift indicates the economy is entering a new phase of moderate recovery. This report systematically analyzes the driving forces, transmission mechanisms, and historical patterns of the current PPI rebound to assess the trajectory of stock indices and provide investment strategies.
Beginning in the second half of 2022, influenced by weak global demand and domestic overcapacity, the PPI experienced a prolonged downturn. This led to shrinking profits for industrial enterprises and a protracted slump for cyclical sectors in the capital markets, creating a negative feedback loop of weak demand, falling prices, and poor profitability. July 2025 marked an inflection point, with the month-on-month change turning positive and continuing to rise. Subsequently, the year-on-year decline narrowed each month, culminating in a positive reading of 0.5% in March 2026, with the monthly increase reaching a 48-month high. This recovery exhibits four key characteristics: First, the drivers are diverse, fueled by international commodity prices, domestic growth stabilization policies, new growth industries, and supply-side governance. Second, there is significant sectoral divergence, with upstream resource sectors leading, midstream materials sectors following, downstream consumption sectors lagging, and new growth industries maintaining independent high growth. Third, the linkage with the Consumer Price Index (CPI) is weak, reflecting a scenario of rebounding production but moderate end-consumption, with limited inflationary pressure. Fourth, the recovery is gradual, following a path of "monthly growth turning positive, annual decline narrowing, annual growth turning positive."
The PPI influences stock indices through four primary transmission channels: corporate profits, liquidity, risk appetite, and sector rotation. Regarding profits, upstream sectors benefit directly with the highest profit elasticity; midstream sectors face initial pressure followed by gradual improvement; downstream sectors remain pressured by relatively weak end-demand. In terms of liquidity, monetary policy is expected to remain accommodative against the backdrop of a mild rebound, supporting valuation recovery. For risk appetite, economic recovery signals boost market confidence, attracting incremental capital. Sector rotation follows a clear sequence: growth stocks lead initially, followed by cyclical stocks, with consumption and stable sectors concluding the cycle.
A review of five historical PPI recovery cycles in China reveals a three-phase pattern for stock index performance. Phase One (from the trough in monthly growth to the trough in annual growth) is characterized by valuation repair, where growth stocks, particularly in TMT and power equipment sectors, outperform. Phase Two (from the trough in annual growth to positive annual growth) sees a共振 of profit improvement and valuation expansion, leading to a balanced market rally across growth, cyclical, and consumption sectors. Phase Three (from positive annual growth to the peak) involves high-level consolidation, where growth and cyclical styles dominate initially, gradually giving way to stable styles, with capital shifting towards defensive, low-valuation sectors. The current market is transitioning from late Phase Two to early Phase Three, highlighting the allocation value of growth and cyclical sectors.
For the second and third quarters of 2026, the PPI is expected to climb steadily to a range of 2%-3%. Corporate profits are projected to continue improving, supported by a friendly monetary policy stance and ample liquidity. Both A-shares and Hong Kong stocks are likely to experience structural gains. An investment strategy of balanced allocation across "Cyclicals + Growth + Defensives" is recommended. The core allocation should focus on high-elasticity cyclical sectors like oil & gas, coal, and non-ferrous metals. The growth allocation should target high-growth areas such as computing power, energy storage, electronic materials, and semiconductors. The defensive layer should include stable-yield sectors like banks and utilities to capture the profit recovery driven by the PPI rebound.
Risks to monitor include a potential decline in commodity prices, slower-than-expected domestic demand recovery, inflation exceeding expectations, and tightening external liquidity. Close attention should be paid to the sustainability of the PPI recovery, the realization of corporate profits, and shifts in policy direction.
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