Based on positive shifts in both supply and demand dynamics, we maintain a favorable outlook on China's midstream manufacturing sector. Building upon our prior macro-level research series, we now explore how to translate these views into actionable stock selection strategies.
First, regarding the overarching stock selection philosophy, we aim to base our approach on three key premises. The selection process should be multi-dimensional to reduce the probability of misjudgment. Each dimension of analysis should have clear linkages to both macro and micro factors; macro linkages emphasize the underlying logic reflecting ongoing changes at the macroeconomic level, while micro linkages focus on financial metrics that indicate the actual impact on companies. Finally, a stock selection strategy synthesized from multiple dimensions should aim to deliver relative outperformance.
It is important to emphasize several points. This analysis is not a standard quantitative stock selection model. It does not account for trading-level issues such as trading halts and thus does not constitute a formal quantitative process; rather, it uses quantitative terminology to express a top-down, macro-driven stock selection logic. For consistency, our series of reports defines China's midstream manufacturing in line with the National Bureau of Statistics' definition of the equipment manufacturing industry. However, the core bullish logic for midstream manufacturing can be reasonably extended to other sectors. Companies in other industries exhibiting similar characteristics should also warrant attention. Due to data availability constraints, applying macro logic to micro stock selection faces challenges such as broad industry classifications, limited quantitative data for specific logic application, and timeliness issues arising from waiting for full financial data disclosure from all companies. Incorporating additional bottom-up, forward-looking analysis is expected to yield better results.
Our specific methodology is as follows: Based on four key macro rationales for a bullish stance on China's midstream sector—increasing supply scarcity, rising overseas security demand, improving supply-demand dynamics, and continuous technological advancement—we translate these into specific micro financial metrics. We construct four corresponding indices: the HALO Index, the External Demand Exposure Index, the Supply-Demand Improvement Index, and the Technological Progress Index. Utilizing these four indices, we construct the China Midstream 100 Index. Over the past two years, this index has demonstrated significant outperformance compared to major broad market indices like the CSI 300, CSI 500, and CSI 1000, potentially reflecting growing market recognition of the bullish thesis for China's midstream sector. We suggest that bottom-up stock selection can be enhanced by integrating these macro-level perspectives.
Regarding the midstream composition of major broad indices, the ChiNext Index has a high concentration of midstream companies, making it a potentially good proxy for tracking the profitability and price trends of the midstream sector. Furthermore, comparing the profit percentile versus valuation percentile of major indices, the ChiNext Index's valuation appears relatively low compared to its profit ranking. Therefore, we suggest the ChiNext Index could serve as an alternative observational gauge for China's midstream sector.
**Report Summary**
**Dimension 1: Supply Capacity Premium** The macro rationale posits that two major transformations—the AI revolution and changes in global governance rules—are increasing the scarcity of physical assets. At the micro level, we construct the HALO Index: (Fixed Assets + Construction in Progress) / Total Assets * ln(Per Capita Fixed Assets in '000 CNY). Since 2025, the importance of the HALO Index has been increasing, both for the overall A-share market excluding financials and specifically for midstream manufacturing.
**Dimension 2: Security Demand Surge** The macro rationale suggests that increasing global military and trade conflicts are fueling security anxieties among nations, leading to persistent demand for energy security, national defense security, technological security, critical mineral security, and supply chain security. At the micro level, we construct an External Demand Exposure Index. Companies with greater exposure to external demand may hold a first-mover advantage. Data from the last three years indicates that stocks with higher external demand exposure have performed better.
**Dimension 3: Improving Supply-Demand Dynamics** The macro rationale identifies factors such as anti-internal competition measures, high oil prices, and increasing export diversification as contributing to improved supply-demand balances. At the micro level, we construct a Supply-Demand Improvement Index: Gross Profit / Fixed Assets. It is crucial to note that financial metrics like gross margins lag behind changes in the macro landscape; forward-looking micro judgments are often more critical. For instance, analyzing the supply concentration (measured by the top 10 global exporters' share) versus demand concentration (measured by the top 10 destinations for Chinese exports) for various product categories can provide insights. For many midstream products exported by China, supply concentration is more favorable than demand concentration, suggesting a potential widening pool of categories benefiting from improving dynamics. Based on 2025 quarterly report data, selecting midstream manufacturers with stronger Supply-Demand Improvement Indices has yielded significant outperformance compared to the weaker cohort.
**Dimension 4: Technological Advancement Dividends** The macro rationale highlights the significant technological progress of Chinese manufacturing driven by continuous innovation investment. At the micro level, we construct a Technological Progress Index comprising metrics for R&D investment growth and contract liability growth. The logic is that increased R&D spending is a necessary condition for technological breakthroughs. Concurrently, breakthroughs often lead to short-term supply shortages, increased orders, and rapid growth in contract liabilities. Based on 2025 quarterly report data, selecting midstream manufacturers with stronger Technological Progress Indices has yielded significant outperformance compared to the weaker cohort.
**Summary: Constructing the China Midstream 100 Index** The compilation process is as follows: After financial report data disclosures at the end of April, August, and October, the four indices (HALO, External Demand Exposure, Supply-Demand Improvement, Technological Progress) are updated. The index selects the top 100 stocks that rank within the top 60th percentile across all four indices and have relatively larger market capitalizations.
Over the past two years, as of April 14th, the China Midstream 100 Index achieved a cumulative return of 118%, outperforming major broad market indices. The CSI 300, CSI 500, and CSI 1000 returned 30.4%, 48.7%, and 48.2% respectively over the same period. The ChiNext and STAR 50 indices returned 91.5% and 83.1% respectively.
Notably, compared to major broad indices, the price trend of the ChiNext Index closely mirrors that of the China Midstream 100 Index. The ChiNext Index's composition shows that midstream companies account for over 70% of both its total market capitalization and profits. Furthermore, the ChiNext Index's valuation percentile appears relatively low compared to its profit growth percentile. Therefore, we suggest the ChiNext Index can be viewed as a viable alternative proxy for observing the Chinese midstream sector.
Risk Warning: The stock selection model does not constitute investment advice. Past performance is not indicative of future results.
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