CITIC SEC: K-shaped differentiation reaches a stage of extreme A-share trend shows greater resilience.

CITIC SEC released a research report stating that in early May, the strengthening of the US dollar and the rising expectations of interest rate hikes corresponded to the accelerated differentiation of the global market's K-shaped pattern. The core issue is the damage to demand in non-AI sectors due to tightening expectations. As the market has progressed to the current stage, the K-shaped differentiation has reached a temporary extreme, even within the overseas technology sector there has been consolidation. The pricing of stocks, bonds, commodities, and currencies has already reflected early signs of declining trade; if further tightening measures are implemented, it may further damage demand in the carbon-based world. Conversely, the K-shaped differentiation may have the potential to temporarily converge. Compared to the more volatile overseas market, the A-share market has shown more resilience in its trends. Some non-AI sectors have already shown signs of capital inflow, with some undervalued sectors showing signs of recovery and just waiting for opportunities. CITIC SEC's main viewpoints are as follows: 1. In early May, the strengthening of the US dollar and the rising expectations of interest rate hikes corresponded to the acceleration of the K-shaped differentiation in the global market. When comparing expectations of USD liquidity and the equity market's K-shaped differentiation, the K-shaped differentiation since the beginning of the year can be divided into three stages: the first stage was from the beginning of the year to the end of February, during which there was still speculation about a loose monetary policy by the Fed and the USD index weakened from 100 to around 96, with no significant K-shaped differentiation in various markets. The second stage was from the end of February to April, when the market began to reconsider hawkishness, the USD index rebounded, and the K-shaped differentiation in various markets began to emerge. The third stage is from May to the present, with further heating up of interest rate hike expectations, the USD index reaching a yearly high, and non-US market's K-shaped differentiation intensifying, leading to a noticeable gap with US stocks. In addition, this third stage also corresponds to a significant retreat in non-AI sectors of the A-share market, with cyclic stocks becoming noticeably weaker than overseas counterparts. In the report titled "A-share Strategy Focus 20260621 - 'Interest Rate Hike' Boosting Technology?", we analyze the impact of interest rate hikes on the global market's K-shaped differentiation, where significant differences in prosperity levels cause interest rate hikes to negatively impact non-AI sectors far more than AI sectors. From this perspective, when the narrative of interest rate hikes and the strengthening of the US dollar cools down, K-shaped differentiation may potentially ease temporarily, and style balance may follow suit. 2. The K-shaped differentiation has reached an extreme, and the technology sector within the overseas market is also consolidating. Market narratives and capital forces may push reasonable trends to overly priced extremes periodically, under the continuous heating of tightening expectations and the market's increasing threshold for prosperity levels. Reflected in the market, even US stocks have shown signs of consolidation within the technology sector. Since May, when the market believed that the month-over-month growth rate of ARR for Anthropic had slowed down, combined with downstream companies beginning to control token budgets, the Nasdaq began to consolidate, and Mag 7 has been continuously adjusting, falling by 12% as of June 26 from its high point. The previously resilient optical communication sector has experienced high-level fluctuations since mid-May, while the previously rebounding application sector has come under pressure again since June. The semiconductor sector in US stocks performed well earlier, but in June, the semiconductor index also began to experience high-level fluctuations, with a weekly drop of 7.9%. Currently, only leading storage companies are continuing to rise due to strong financial reports. 3. Overseas pricing of risk assets already shows signs of early stage declining trade, tightening may further damage demand in the carbon-based world. Recently, overseas assets have displayed a combination of rising USD, falling US stocks, and commodities, including oil prices. The decline in oil prices has eased long-term inflation expectations but has not affected short-term inflation stickiness. On June 25, the US Department of Commerce announced the May PCE inflation data, showing an overall year-on-year increase of 4.1%, and a core PCE year-on-year increase of 3.4%, the highest since 2023, indicating that inflation in the US is highly sticky and not solely caused by oil prices. The latest market narrative suggests that the strong demand for AI has squeezed a large amount of commodity resources, leading to the "carbon-based" world having to pay higher prices, resulting in inflation, forcing the Fed to raise interest rates. The news of Apple raising consumer electronic prices due to increased memory costs further reinforces this narrative, with the market understanding that if the Fed is forced to raise interest rates to counter structurally-driven inflation, it may further damage demand in the carbon-based world. At the same time, the rise in real USD interest rates is believed to be due to AI's relative competitive advantage bringing high economic growth, making the USD extremely strong. However, the rapid flattening of the US Treasury yield curve indicates that this narrative is temporary. Currently, the 10-year-2-year yield spread is 0.31%, significantly lower than the 0.58% of early March, displaying a noticeable flattening trend at the 28th percentile over the past 20 years. The market's reflection may suggest that tightening measures or further damage to demand in the carbon-based world could ultimately harm long-term economic growth expectations. Overall, the pricing model of risk assets is highly contradictory, possibly due to the growth effects brought about by AI technology innovation staying within the small cycles of hardware manufacturers, model manufacturers, and cloud service providers, without broad integration into the larger economic cycle. This also means that although the K-shaped differentiation has its validity, it also has its vulnerabilities. 4. The A-share market shows more resilience, with signs of capital inflow into some non-AI sectors. In recent times, the technology sector in A-shares has shown stronger resilience compared to overseas markets, especially in the domestically produced computing power sector displaying trends independent of overseas markets. Overseas-linked companies in A-shares have adopted a similar pricing logic to overseas cyclic stocks, while domestically-linked firms, under the narrative of domestic substitution and independent controllability, have shown additional growth premium trends. Besides the technology sector, some non-AI sectors have already shown signs of incremental capital inflow due to previous adjustments. Sectors such as securities and chemicals are quite typical in this regard, with the trading proportion of securities + chemicals reaching a new high for the year, showing significant volume, and on certain trading days being able to rise alongside AI sectors, with stock prices showing clear signs of recovery. For the securities sector, the left-side logic is supported by three clues: "undervaluation + weakening selling pressure from the financial side + catalysts from the technology IPO frenzy"; for the chemicals sector, the core drive comes from a rebound in oil prices entering the "sweet spot" range, and the counter-trend expansion of the price difference, with some companies producing 'within expectations' impressive interim reports, leading to strong stock price performance, indicating that market funds are not heavily invested, and competition is not extremely intense. Although it is rare for non-AI sectors to resist capital drainage and see rare rises in the recent period, at least it indicates that there are still many off-market funds watching opportunities in non-AI sectors within the A-share market, although marginal changes are not enough to drive a wider influx of off-market funds. 5. Some undervalued non-AI sectors in A-shares have already laid the groundwork for recovery, just waiting for opportunities. From May onwards, non-AI sectors in A-shares have performed weaker compared to non-AI sectors overseas, already having fully reflected negative expectations such as demand decline, monetary tightening, and setbacks in Middle Eastern talks. Currently, these sectors have built a certain level of cost-effectiveness and groundwork for recovery, waiting for some positive changes in their narratives. This change may come from an unexpected drop in oil prices due to the opening of the Taiwan Strait for navigation, dampening inflation expectations, or from a simultaneous recovery in global industrial production and social activities in non-AI areas. In the market environment of a strong USD and rising expectations of interest rate hikes, our selection of securities needs to be more precise and patient, as, without significant marginal changes, the recovery of weaker sectors will not be smooth, and may even face adjustments in sync with the strong sectors. In terms of specific allocations, we still recommend adhering to an AI + Energy Chemistry structure. On the AI side, we continue to favor storage, gas turbines, diesel generators, semiconductor equipment, and materials. In the energy chemistry field, we are positive on the performance of various products such as electrolytes and additives, separators, etc.; in the chemical sector, the decline in oil prices and volatility brings about demand for stockpiling and operational needs, and the expectation of macro liquidity peaking could be a potential rhythm point in the future. Currently, we prefer some cost-effective varieties with significant cost reduction space, relatively strong demand, and low valuations, such as refrigerants, phosphorus chemicals, spandex, dyes, and petrochemicals; in the non-ferrous metal sector, we recommend metals with some exposure to AI but suppressed valuations due to interest rate hike narratives, such as tin, copper, and select minor AI metals (tungsten). Additionally, we continue to recommend increasing allocations to undervalued securities, as the constraints on liquidity at present may gradually fade away in the second half of the year, and interim reports may act as a catalyst. Overall, the allocation structure needs to be nimble and responsive to changes in the market environment, and adjustments may need to be made based on changing narratives and performances of different sectors.