The A-share market experienced a style rebalancing this week, aligning with our earlier expectations. Overseas markets also saw significant volatility on Friday, with a sharp correction in the silicon-based economy, exemplified by the Philadelphia Semiconductor Index. This suggests a degree of global market divergence regarding whether the profits of companies in the rapidly rising and overheated silicon-based upstream sectors can continue to exceed optimistic expectations.
In our discussions with institutions this week, most relative-return funds focused on growth styles expressed skepticism about the sustainability of the current style rebalancing. They view the silicon-based upstream sectors, represented by optical communications and semiconductor equipment, as the current high-certainty, high-growth direction within the AI industry. Conversely, they are less optimistic about the future prospects of the so-called carbon-based economic sectors, such as finance, real estate, consumer goods, and cyclical industries. Key concerns include the negative wealth effect from declining property values suppressing consumer spending and the potential for AI to replace carbon-based jobs, thereby capping income growth. We believe the overly pessimistic view some investors hold towards the carbon-based economy may not fully account for China's unique circumstances. The fundamentals of China's carbon-based economy are showing signs of short-term improvement and retain substantial medium-term growth potential. Consequently, we see a potential for the revaluation of leading carbon-based assets in the Chinese stock market, and a shift towards a more balanced market style away from the recent concentration on a few high-growth sectors. The core reasons are as follows:
First, Leading Indicators for China's Carbon-Based Economy Show Marginal Improvement
We observe that key Chinese indicators such as real estate, PMI, PPI, and CPI have outperformed last year's levels and show potential for further improvement. Real estate serves as a leading indicator for domestic demand, with transaction volumes and prices in first-tier cities stabilizing sequentially. The overall trend in China's real estate market is also more favorable than in the past five years. On the production side, the manufacturing PMI indicates that domestic industrial demand is stronger than last year. Most importantly, the absolute levels of China's PPI and CPI are higher than last year and exhibit a recovery trend. A rebound in prices signals steady improvement in end-demand and profitability.
Second, Divergent AI Development Paths Between China and the US
The market notes that the current US economy exhibits characteristics of "silicon-based inflation but carbon-based deflation," partly linked to the US AI model rapidly advancing the replacement of carbon-based jobs. China's approach primarily focuses on AI empowering the real economy, and its institutional advantages also provide a safety net for carbon-based employment. Therefore, the opposition between silicon-based and carbon-based sectors and the social "K-shaped" divergence seen in US AI development are not directly applicable to China. It is inappropriate to base pessimism about China's carbon-based economy on this US model.
Third, Chinese Policy is Expected to Strengthen Support for Expanding Domestic Demand
We anticipate that in the second half of the year, as risks of overseas stagflation increase, China's efforts to support and expand domestic demand may exceed market expectations.
Fourth, China's Carbon-Based Economy Retains Significant Medium-Term Growth Space
According to the "15th Five-Year Plan," China's GDP is expected to maintain substantial growth over the next five years, laying the groundwork for doubling the per capita GDP by 2035 compared to 2020. Furthermore, as China's comprehensive national strength grows, the global recognition and market share of Chinese brands are also expected to rise.
Fifth, Valuation Disconnect in Key Sectors
The carbon-based economy constitutes a major component of both the Chinese economy and A-share corporate profits. However, there is a significant asymmetry between institutional allocation, market trading share, and profitability in these sectors. Many related sectors and leading companies are trading at low valuation levels. Overall, we believe this provides a foundation for potential revaluation.
The short-term market is in an earnings vacuum period ahead of the interim reports, and the valuation environment is influenced by factors like interest rates, liquidity, geopolitical conditions, and hot events. Key short-term events to watch include: 1) The impact of US May CPI data and the latest Fed stance on liquidity expectations; 2) The effect of SpaceX's IPO on the micro-liquidity of existing US stocks and its post-listing performance on tech stock risk appetite; 3) Progress in US-Iran negotiations affecting the next phase of oil prices and inflation expectations; 4) Whether US tech stock trends stabilize, and South Korea's response to stock market leverage risks, impacting global tech stock risk appetite; 5) The potential diversion of attention and liquidity from global stock markets due to the World Cup. Overall, we assess that while the A-share market faces no systemic risk from a fundamental perspective, the short-term external environment carries some uncertainty. We advise maintaining controlled volatility and avoiding excessive risk appetite. Structurally, we favor continued rebalancing. In terms of allocation, a cross-cycle and counter-cyclical mindset can be adopted, not necessarily concentrating further on current high-growth pro-cyclical sectors, but broadening focus to include high-quality value blue-chip companies with medium-term fundamental logic that are currently at relatively low levels and valuations.
Key Sectors to Monitor
Coal, real estate, securities brokers, insurance, banking, internet, new consumption, construction machinery, new energy, optical communications, semiconductor equipment, non-ferrous metals, etc.
Risk Factors
US-Iran geopolitical conflict duration exceeding expectations, leading to rising global stagflation risks; persistently weak fundamentals in domestic real estate, infrastructure, and the domestic demand chain, with recovery strength and pace falling short of expectations; a bursting of the overseas AI bubble.
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