Shenwan Hongyuan Strategy Reiterates China's Capital Market Stability: This Is Just the Adjustment Period After the "First Phase of Rise" in A-shares

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Source: [Shenwan Hongyuan Strategy | Weekly Review and Outlook] Once again on the stability of China’s capital markets

(Source: Shenwan Hongyuan Strategy)

I. Is the pricing of the medium-term stagflation risk insufficient? We reiterate that stagflation itself has uncertainties. Neither tight monetary policy in China and the U.S. is a baseline assumption. At the same time, potential upside signals in A-shares have also not been priced in adequately. New energy’s high growth in combination with subsequent export-chain Alpha and the ability to pass on price increases through order pricing validation → Middle East capital pricing + the resonance of foreign capital returning → A-shares reflect the impact of energy security and supply-chain security. This could be a clue that A-shares may return to a stronger posture more quickly. Both upside and downside risks have not been priced in sufficiently; for the short term, A-shares are not in stable equilibrium, but they are also in neutral pricing. In the short term, global capital markets are still pricing around event-driven catalysts stemming from the U.S.-Iran conflict, and it is not the moment to make a heavy bet.

Currently, market scenarios for the U.S.-Iran conflict’s impact still mainly follow the logic chain of: “Shipping through the Strait of Hormuz is weak → Oil prices rise → Inflation expectations move up → Concerns about the Fed’s rate hikes intensify → Concerns about stagflation intensify.” Some investors worry that medium-term stagflation may objectively exist, but since market pricing is not sufficient, they believe the market is overly optimistic. In our view, A-shares’ short-term pricing is not in a steady state, but it is also in a neutral state. First, the stagflation scenario itself has uncertainties. In the face of imported inflation, the optimal choice for monetary policy in both China and the U.S. may not be tightening. China’s inflation base is low + the structural policy framework is mature—there is an absolute high likelihood that China will not tighten. The U.S. job market is relatively weak, and it has also become an oil exporter; the forces driving inflation in a positive feedback loop are limited. Supporting U.S. manufacturing “onshoring” requires a weak dollar, low interest rates, and low costs. Raising rates to respond to an upward shift in the inflation core in a one-off manner is evidently not the optimal choice. If tightening policy is in doubt, then the pressure from economic downturn can also be kept under control.

At the same time, we point out that potential upside signals in A-shares are also far from being priced in adequately. A rise in the energy “center of gravity” could mean that the new energy / new-energy vehicle industry chain becomes a mid-term direction of strong business performance. China’s energy security + supply-chain security; in some segments of the export chain, an Alpha storyline may unfold. When facing rising costs, the ability to pass on prices effectively can form a new direction of fundamental trend. This落地 (implementation) structure may also see the optimistic expectations of a country-relative strength play out in line with the resonance of “Middle East capital pricing + foreign capital returning.” Under the baseline assumption, for A-shares to return to strength, it requires validation of the “leap-forward progress” of the new economy and/or cyclical improvement in fundamentals. By repricing opportunities along the manufacturing investment theme, it could form clues for A-shares to quickly return to a strong posture. With both upside and downside risks not priced in sufficiently and the mid-term outlook scenario still not converging, A-shares are still not in stable equilibrium in the short term—but they are also a neutral state.

Under these circumstances, in the short term, global capital markets will still be priced around event-driven catalysts tied to the U.S.-Iran conflict. In the absence of mid-term consensus, the process of easing tensions in the U.S.-Iran conflict is also bound to be a series of ups and downs. The market remains sensitive to near-term event-driven catalysts, which means that this is not the time to make a renewed heavy bet based on mid-term expectations.

II. Once again on the stability of China’s capital markets: high energy self-sufficiency rate + diversified external energy supply to build energy security; a re-evaluation of the advantages of new energy. The resonance between supply-chain security and energy security gives export opportunities with Alpha and a window to pass on prices effectively that may open again. The underlying base for healthy development of the A-share market remains unchanged; policies to safeguard market expectations will support stability. A-shares remain in a medium-to-long-term upward cycle: the earnings effect accumulates when it encounters disturbances, but these are only the “rest periods” after the “first stage rally.” A-shares still have a high likelihood of a “second stage rally.” After a short-term correction, the distance to the target of dynamic valuation returning to the historical median (“in the scenario of a ‘two-stage rally’,” the target location for valuation adjustment during the consolidation/oscillation phase) is not far off. A-shares’ intrinsic stability may gradually improve.

Stability of China’s capital market is the goal that the policy of progressing steadily and achieving long-term results will protect. We have three levels of discussion on this:

1. Energy security and supply-chain security are the foundation for maintaining overall stability in China’s capital markets. China has a high energy self-sufficiency rate, and external energy supplies are diversified. As the energy price “center” rises, China’s new energy advantages will be re-evaluated again. At the same time, based on energy security and supply-chain security, China’s exports have an Alpha logic and the direction to pass on prices effectively toward the outside world will gain additional support.

2. The underlying base for healthy development of the A-share market remains unchanged. The balance of the A-share market’s investment and financing functions has already been clearly optimized. The key is improving the quality of listed companies, which drives a more diverse range of sources for investment returns. In addition, when the stability of China’s capital market faces major challenges, it is only proper that policies of progressing steadily and achieving long-term results come into play. The market has already formed relatively stable and positive expectations for this, making the policy of progressing steadily and achieving long-term results work at greater effectiveness—and this cycle is no exception.

3. A-shares are still in a medium-to-long-term upward cycle. What we are in now is just the adjustment period after the “first stage rally,” and the “second stage rally” is a matter of time, not a question of whether it exists. We maintain our judgment of a “two-stage rally” in A-shares. Currently, we are in a consolidation and adjustment swing after the “first stage rally.” Referencing historical experience: if there are no major negative shocks at the macro and industry levels, the consolidation adjustment could last about one quarter; but if there are negative shocks at the quarter level in industries/macroeconomy, the adjustment time may extend to two quarters; and if negative news persists, the largest level of adjustment after the first stage rally can be referenced against 2018. But at this stage, even if the external environment is weak, the internal environment is significantly better than 2018. And once negative factors ease, A-shares will return to the path of accumulating the earnings effect. Ultimately, a quantitative change leads to a qualitative change, and the start of incremental capital will enter a positive cycle.

The target location for valuation adjustments during the consolidation and adjustment stage is: digesting valuation through earnings performance + digesting valuation through pullbacks, so that the final static valuation returns to around the historical median. After short-term rapid adjustments, the distance to the target is not far. Combined with the policy of progressing steadily and achieving long-term results, A-shares’ intrinsic stability may gradually recover.

The consolidation and rest phase in the middle of a two-stage rally, with the technology mainline extending + the macro narrative expanding, is still the primary source of high-elasticity investment opportunities. During this phase, the independent opportunities for sub-industries still retain elasticity, but sector linkage is relatively weak; therefore, the earnings effect is difficult to spread broadly. In the technology “reality-realization” direction that was strong before the U.S.-Iran conflict, there is still an opportunity in the short term. Focus on CPO, energy storage, and AI power. In the next stage, new energy and new energy vehicles may become the new leading-up direction. This is a direction that could resonate with the macro narrative, with upside elasticity and an earnings effect that can spread.

During the consolidation and rest phase, high-elasticity investment opportunities still come from the technology mainline extending + the macro narrative expanding. The core feature of this phase is that independent trading opportunities in sub-industries continue to appear one after another, and leading sectors sequentially play out a process of “industry catalysts → repricing with valuation expansion → valuation at historical highs, and the rally hits resistance.” However, sector linkage is relatively weak, so the earnings effect is difficult to spread widely.

Recently, during the stage when risk appetite is pressured by the U.S.-Iran conflict, high-elasticity investment opportunities have generally been suppressed. But after signals of easing in the U.S.-Iran conflict emerge, rotation among high-elasticity sectors remains effective. In terms of specific directions, the technology “reality-realization” theme that was strong before the U.S.-Iran conflict still has elasticity in the short term. Focus on CPO, energy storage, and AI power. For subsequent rotation directions, we mainly focus on investment opportunities in new energy and new energy vehicles. New energy benefits from energy diversification and the trend toward making energy supply less vulnerable to shocks; it may, together with traditional energy, become an important strategic resource. At the same time, new energy may become a structural foundation for foreign capital to return and for the re-evaluation of relative country strength—this is a direction with upside elasticity and an earnings effect that can spread.

Risk warning: overseas economic recession worse than expected, and domestic economic recovery not meeting expectations

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