JPMorgan believes the recent correction in A-share AI-themed sectors is fundamentally a deleveraging process, not a signal of deteriorating fundamentals, and that the long-term investment thesis for China's AI ecosystem remains intact.
In a report dated July 15th, JPMorgan's China equity strategist Zhang Xiaoning explicitly stated the bank does not subscribe to the market narrative of an imminent "bubble burst," supporting this view with three key factors: the health of corporate balance sheets, the continued improvement in large language model capabilities, and the short-term difficulty in resolving AI hardware supply bottlenecks. On liquidity, the proportion of margin-financed trading in the A-share IT sector has fallen from a mid-term peak of around 12% to 8%-9%, indicating that the most leveraged positions have been largely forced out and the deleveraging process is largely complete.
Looking ahead, JPMorgan maintains its base-case target for the MSCI China Index at 100 points and for the CSI 300 Index at 5,200 points by the end of 2026. It advises investors to continue holding quality large-cap AI stocks during short-term volatility, anticipating that China's AI ecosystem could regain leadership during the August earnings season.
Liquidity Indicators Pointing to Deleveraging Nearing Completion
JPMorgan analyzed two key liquidity metrics to assess the nature of this pullback.
First, turnover has slowed but not collapsed. While the 5-day rolling average trading volume for A-shares has retreated significantly from its cycle high of around 6.5%, it remains above previous lows seen at market bottoms. This pattern aligns more with a market undergoing "de-frothing" than with a collective exodus of institutional investors. Second, margin trading deleveraging is essentially finished. The proportion of margin-financed trading in the A-share IT sector's total turnover has dropped from a mid-term peak of about 12% to 8%-9%, signifying that the most aggressively leveraged positions have been largely cleared.
More notably, ETF fund flows into A-shares have turned positive since early July, with semiconductor and tech hardware ETFs seeing the most pronounced net inflows. From July 1st to 13th, semiconductor ETFs averaged a daily net inflow of 1.2 billion yuan, while tech hardware ETFs averaged 350 million yuan. JPMorgan views this as further evidence supporting the healthy correction thesis, rather than a sign of systemic risk contagion.
Balance Sheet Check: Still in Healthy Territory Compared to Historical Bubbles
Citing Bloomberg data, JPMorgan notes that the latest debt-to-asset ratios for China's hyperscale cloud service providers (Tencent, Alibaba, Baidu) and their U.S. peers (Amazon, Alphabet, Microsoft, Meta) are all around 40%. This is far lower than the average leverage of approximately 100% for Chinese property developers at their 2021-2022 peak and not comparable to the extreme leverage of around 230% seen in telecom operators like Global Crossing and Level 3 Communications during the 2001-2002 U.S. dot-com bubble.
From a bond rating perspective, these hyperscale cloud providers all maintain investment-grade ratings: U.S. cloud giants range between "A+" to "AAA," while Chinese counterparts range between "BBB+" to "A+." JPMorgan believes that, although recent bond issuances have widened the option-adjusted spreads for some companies, the overall balance sheets remain robust, fundamentally different from the financial structures seen before historical bubble bursts.
Technical Evolution and Demand Expansion: Upside Potential Remains
JPMorgan views the continuous iteration of large language model capabilities as a core pillar supporting the sustainability of AI capital expenditure. The report notes that China's leading models are striving to catch up to the performance levels projected for leading U.S. models by mid-2026. Each new generation of more powerful models unlocks new enterprise and consumer use cases, driving incremental investment in infrastructure.
On the revenue front, annual recurring revenue (ARR) for the entire AI sector is accelerating, and order visibility for China's AI supply chain has improved significantly. JPMorgan argues that the current AI investment cycle is not yet constrained by demand saturation. The positive feedback loop of technological progress creating new scenarios, which in turn drive ARR growth, continues, providing upside potential for valuations.
Hardware Bottlenecks: Supply Constraints to Persist Until at Least 2028
JPMorgan detailed the global AI hardware production timeline, concluding that supply constraints for key components are unlikely to ease before late 2027 to 2028 at the earliest. This means the next two quarters will not be a window for testing the sustainability of AI capital expenditure.
On the global supply front, TSMC's Arizona fab is slated to begin 3nm mass production in the second half of 2027, Micron is advancing HBM memory production in both the U.S. and Singapore, while SK Hynix's CEO has warned of the most severe memory shortage in history by 2027. JPMorgan expects large-scale release of global HBM supply and a genuine easing of shortages will only materialize in 2028. The bank believes this constraint, in fact, reinforces the pricing power and urgency of AI infrastructure spending.
Strategic Recommendation: Hold Quality AI Large-Caps, Watch for Short-Term Rotation
Following the correction, the forward price-to-sales multiples and valuation dispersion for China's overall AI ecosystem have returned to more reasonable levels. JPMorgan recommends continuing to hold quality AI large-cap stocks amid short-term liquidity fluctuations. In the near term, the bank expects the market may continue its rotation from AI to non-AI sectors in July, potentially catalyzed by the earnings season for securities brokers, insurance, and healthcare.
The bank maintains its base-case target of 100 points for the MSCI China Index and 5,200 points for the CSI 300 Index by end-2026. JPMorgan believes China's AI ecosystem will regain market leadership during the August earnings season, supported by second-quarter financial results and guidance for the second half of the year.
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