CITIC Securities: How to deal with rapidly rotating markets

The Zhitong Finance App learned that CITIC Securities released a research report saying that after 2022, “rapid structural rotation” of A-shares is the norm. Extremely high rotation speed generally lasts 1 to 2 months. The common denominator behind high-speed rotation is that profit improvement is insufficient in breadth, and sustainable main lines are scarce. Currently, trade frictions are entering a period of high incidence, and the impact of exchange gains and losses is also increasing. Going overseas, as one of the most important performance clues for A-shares, is constrained by valuation restrictions, limiting the breadth of the market, and it is easy to form a rapidly rotating market state in the industry. Breaking the impasse requires new changes. Recent advances in AI have strengthened the existing trend of rapid growth in computing power demand, but they are not enough to change the long-term commercialization narrative. If we see possible new changes such as RSI and anti-distillation in the future, it is expected to open up room for long-term valuation.

In the stage of rapid market rotation, most of the winners are “undervaluation” strategies, but only the PB-ROE strategy clearly dominates in a rapid rotation environment, and the yield of the strategy further increases as the rotation speed increases. The momentum strategy is the most damaged strategy during the rapid rotation phase. Under high rotation, market opportunities may be reflected more as valuation repairs with performance support. In terms of configuration, the bank proposed an “AI+ energy conversion” barbell structure in its mid-term strategy. AI was concentrated in Q2, and energy efficiency may gradually heat up in the future.

CITIC Securities's main views are as follows:

After 2022, “rapid structural rotation” of A-shares is the norm, and the extremely high rotation speed generally lasts 1 to 2 months

We have constructed a “main line retention rate” index to measure the rate of market rotation. The center of the indicator showed a one-time rise in 2022 (monthly average 0.71 → 0.77), and A-shares have since entered the normal “structural fast rotation”; the average monthly level of the indicator reached 0.853 in August this year, which is at the historical 97.5% level (higher since 2010 only in early 2016, early 2022, and September 2023). There was still a reading of 0.875 on August 27, indicating that the market is still rotating at a very high speed. However, the state of rapid rotation generally does not last long. Since 2012, a total of 38 periods of high rotation have been identified. The median duration is only 1 month and the average value is 1.9 months. 65% of the stages end after the first month, and only 22% can last more than 2 months. However, the readings in this round are extreme and the 20-day smoothness itself is inertial, so it is impossible to assert that the state of high-speed rotation will end in September based on historical rules alone; it needs to be confirmed in conjunction with profit improvement signals.

The common denominator behind high-speed rotation is that the breadth of profit improvement is insufficient, and sustainable mainlines are scarce

There is a stable concurrent relationship between the narrowing in the breadth of profit improvements and the acceleration of rotation. Since 2015, the proportion of companies with year-on-year improvement in A-share ROE is highly correlated with the main line retention rate index. The more profit improvements are concentrated in a few industries, the greater the fluctuation in these industries (rapid rise followed by rapid adjustment). Once it falls into the stage of digestion and valuation, the market has entered a state of lack of mainline and rapid rotation. Therefore, the core of judging whether high-speed rotation will end is to determine the breadth of profit improvements. We found that the share of consistent profit expectations of large market capitalization companies is an effective indicator for measuring the breadth of profit improvement. It has a strong leading predictive effect on the main line retention rate. The leading cycle is about 1 month, and the two-month smooth index of the performance improvement ratio is stronger in predicting the main line retention rate. If we look at the present, the increase in the performance of large market capitalization companies in July was only 33.8%, and in August it rebounded to 45.5%. We judge that if this share continues to remain above 46% in September, the indicators are a stronger confirmation of the slowdown in the rotation rate of the October market.

Trade frictions have entered a period of high incidence, and the impact of exchange gains and losses is also increasing, limiting the breadth of the market and making it easier to form a rapid rotation

Recently, economic, trade and technological frictions between China and the US have clearly heated up, and policy tools have shown a trend of spreading from enterprise lists to product access, key supply chains, and universal tariffs. Since late July, the US has successively tightened access to foreign-made robots, connected inverters, and power grid equipment, while China has strengthened export controls on dual-use items related to US drones. Meanwhile, according to Reuters, US restrictions on data center components such as Chinese optical modules are still being prepared, and are considering imposing an additional 7.5% tariff on Chinese goods on the grounds of “overcapacity.” Although some of the measures have not yet been officially implemented, and consideration of increasing bargaining chips before the leaders' meeting is not ruled out, the intensity of recent friction incidents, covered industries, and policy levels have all risen, increasing the tail risks faced by the high-value overseas industry chain, and may be reflected in market risk appetite and valuation ahead of actual export changes. Trade negotiations between China and Europe have also entered a key verification window. September-October is a stage to test whether technical negotiations between China and Europe can be transformed into substantial results such as market access and trade balance. If repeated, companies with high European exposure may face rising market entry and compliance costs, fluctuations in profit forecasts, and valuation discounts. Furthermore, the interim reporting season once again verified the negative impact of exchange gains and losses on the profits of listed companies in the context of the continuous appreciation of the RMB. For non-financial companies that have published semi-annual reports, overall financial expenses rose 67.4% year on year. The increase in financial expenses accounted for 9.8% of the net profit base for the same period last year. For companies accounting for more than 30% of overseas revenue, the financial expenses ratio increased by 1.41 to 2.52 percentage points year on year (sample average value taken from different overseas revenue share ranges). Although we believe that trade frictions will not change the medium- to long-term trend of internationalization of Chinese enterprises and increased industrial competitiveness, going overseas, as one of the most important performance clues for A-shares, does face valuation constraints in the short term, limiting the breadth of the market, and can easily form a rapidly rotating market state in the industry.

Breaking the impasse requires new changes. Recent advances in AI reinforce existing trends, but not enough to change the long-term narrative

Nvidia's latest financial statements, especially the forward guidance that far exceeded expectations, had a positive impact on many supply chain companies, yet the stock price performance of companies related to the industry chain showed “fatigue.” Recently, the rapid growth rate of TaaS platforms in North America (especially AWS's Bedrock), and the potential huge fund-raising potential of Anthropic's listing (and the subsequent release of computing power investment and more powerful models) have largely dispelled market concerns about the slowdown in commercialization of computing power infrastructure. However, these marginal positive changes are more about strengthening the inherent narrative of “lack of computing power,” and there is still no fundamental change in the long-term narrative of commercialization of terminal applications. In other words, these marginal changes in the industry can help revise profit forecasts, but they cannot change the cyclical stock valuation system for many hardware stocks. At present, the market has formed a consistent expectation that “cutting-edge model manufacturers consume a lot of computing power and costs to drive model progress. Open source models use distillation and post-training to reduce costs, eat up the high-end market through pricing advantages, and application companies use low-cost models and private data as vertical markets”. Recently, Smart Spectrum officially announced that all GLM-5.3-Flash traffic is carried by clusters composed of more than 100,000 domestic chips. The Hy4 released by Tencent shows strong capabilities in most office tasks. The pricing is also only a fraction of the cutting-edge model factory. The business model, in turn, affects the economics of investing huge amounts of computing power in the long term (rather than the current). To change the existing narrative, the marginal increase in model capability or the growth of TaaS platforms is limited, either fundamental technological changes such as RSI establish a stable relationship between computing power advantages and model power generation differences, or breakthroughs have been made in anti-distillation, making it impossible to replicate capabilities at low cost, so we can retell the story of computational power building barriers.

Among the main style strategies, most of the winners in the rapid rotation period are “undervalued” strategies

Since there are currently no changes to change the rapid rotation pattern, we need to find the best coping strategies in this environment. We examined 15 styles of strategies. Among them, the average monthly profit differences between low PE and low PB strategies reached 219 and 196 basis points, respectively, and the differences between PB-ROE (residual balance method), HML value factor, PB-ROE (predicament reversal), and low price stock strategies were 147, 136, 125, and 124 basis points, respectively. Among them, the positive differences between the two strategies based on PB-ROE were statistically significant. Among these strategies, most of them perform well during the high speed market rotation phase and have the characteristic of “undervaluation.” If we place the sensitivity of the strategy to rotation speed and the expected long-term return on the same configuration map, we can divide the strategy into three categories: 1) The first category is a “rotating offensive” strategy such as low PE, low PB, HML value factors, and PB-ROE (residual method). The rotation sensitivity is high, but the long-term average return of some strategies is not prominent, and is more suitable for phased addition during unstable main lines and rapid industry changes; 2) The second category is quality factors, surplus drift, and profit factors, which are not sensitive to round state. However, the long-term benefits are relatively stable, and it is more suitable as a non-dependency The basic position for judging market conditions; 3) The third category is a momentum and boom chase strategy. Its rotation sensitivity is clearly negative. It is more advantageous in a market where the main line is clear and the trend continues, but exposure should be reduced appropriately during the rapid rotation period. Therefore, in the current market environment where the main line is not sustainable enough, the style configuration can be moderately skewed towards undervaluation and valuation-profit matching strategies to reduce dependence on short-term trends.

Only the PB-ROE strategy has a clear advantage in a rapid rotation environment, and the return on the strategy is further enhanced as the rotation speed increases

We use the main line retention rate to divide rotation intensity into three levels. There is only a statistically significant difference in yield between strategies based on PB-ROE and momentum strategies at different rotation speeds, but the PB-ROE strategy benefits, and the momentum strategy is clearly damaged. Under the PB-ROE framework, the traditional residual method strategy outperformed the China Stock Exchange at an average monthly average of 158 bps during the high market rotation period. After adding the “dilemma reversal” factor, the average monthly performance outperformed the China Stock Exchange by 179 bps. The overall historical performance was clearly better than the residual method strategy. Under the PB-ROE (Residual Deficiency Method) strategy, undervaluation and high quality factors contributed to the main excess. The current industries that fit this strategy include industrial metals, coal, logistics, etc.; under the PB-ROE (predicament reversal) strategy, the improvement in the supply and demand pattern and valuation repair brought about by supply clearance contributed to the main excess. Currently, industries that fit this strategy mainly include chemicals, batteries, aquaculture, etc.

The barbell structure of AI+ energy conversion. AI is concentrated in Q2, and energy conversion may gradually heat up in the future

Our mid-year strategy proposed an AI+ energy barbell structure. As the offensive side, AI satisfies aggressive capital's pursuit of high growth and new paradigms, and energy transformation as a steady side to meet the demand for high-certainty returns from allocated capital. What surpassed our expectations was that the two did not coexist; instead, they were staggered in time. When AI was strong in the second quarter, they were able to be siphoned off, but now the opposite is true. This round of energy conversion is likely to reflect price differences more than simply rising oil prices. In fact, according to shipping research institute TankerTrackers, there has been a marked increase in traffic volume in the Strait of Hormuz recently. At least 15 groups of STS transshipment operations were carried out simultaneously in the Gulf of Oman on the same day, involving about 25 million barrels of crude oil and some refined oil products. Sources covered almost all countries in the region other than Iran. The actual number of ships passing through the strait may exceed the apparent data (fleets pass in formation at night and some ships turn off transponders for “dark flight”. Satellite images were mostly taken in the morning, and the AIS aperture was systematically underestimated). However, the impact on global refining capacity is still quite large. The difference in diesel cracking prices is clearly widening, and a situation where there is no shortage of crude oil and a shortage of refined oil products is becoming a reality. Underground production capacity (crude oil) can be restored as soon as the strait is unobstructed, but the recovery of production capacity on the ground (refining, chemical, and chemical) is much slower. In addition, China is still maintaining low operating rates and low inventories, and the factors of weak demand have already been set in. The market may have been very popular with cyclical stocks before, but in reality, the flexibility of the energy chain may be better than the current one. In terms of allocation strategies, control expectations, avoid “grand narratives”, and respond with a volatile market mentality is still the core principle of the moment. Within the technology sector, move positions to core assets (such as gas turbines, wafer manufacturing platforms, semiconductor equipment, etc.), pay more attention to “quantitative certainty”, and treat “price explosiveness” carefully. For the non-technology sector, the focus is on adding energy technology, innovative drugs, and leading brokerage firms with the potential to go overseas.

risk factors

Frictions in the fields of technology, trade, and finance between China and the US have intensified; domestic policy strength, implementation effects, or economic recovery have fallen short of expectations; macro-liquidity at home and abroad has tightened beyond expectations; conflicts in regions such as Russia, Ukraine, and the Middle East have further escalated; and China's real estate inventories have fallen short of expectations.