China Merchants Strategy October Industry Allocation: Focus on Performance Boom Catalysts and Balanced Allocation in Domestic Demand Directions

CMSC released a strategy research report stating that over the past month, the market fluctuated downward, with the growth sector undergoing significant adjustment, while defensive and policy-beneficiary directions were relatively favored. Looking ahead to October, domestic and overseas macro conditions are simultaneously entering a "landing verification" window, and A-shares are expected to move toward "performance as king, balanced offense and defense": domestically, counter-cyclical adjustment is intensifying, domestic demand drags are gradually weakening, and the economy continues to show "moderate aggregate growth, industry leading"; overseas, U.S. inflation stickiness exceeds expectations, and the "growth-price-fiscal sustainability" triangle constraint is deepening, but the stage of maximum pressure on the denominator side is expected to ease as uncertainties are resolved. After domestic and overseas macro conditions land, earnings verifiability becomes the core pricing anchor; at the meso level, the prosperity mainline is moving from "broad gains" to "eliminating the false and preserving the true." Combining multiple dimensions including meso prosperity, profitability, chip distribution, valuation, trading, cycle stage, and track value, October should downplay index fluctuations, focus on prosperity and performance, and at the same time use some domestic demand directions for balanced allocation, with key attention on electronics (semiconductors), power equipment (batteries, grid equipment), non-ferrous metals (industrial metals, precious metals), pharmaceutical biology, agriculture, forestry, animal husbandry and fisheries, and banks. CMSC's main views are as follows: Market Performance Review Over the past month, A-shares fluctuated downward, with the growth sector undergoing significant adjustment, while defensive and policy-beneficiary directions were relatively favored. The market mainline was the game between rising overseas inflation and interest rate pressure and continuously intensifying domestic policy. At the beginning of the month, under the intertwining of recovering fundamental data and rising overseas tightening expectations, the market rose then fell back, high-level technology chips loosened, and risk appetite gradually cooled; in the middle of the month, the Fed's first rate hike of the year landed, the market interpreted it as "bad news exhausted," and technology growth rebounded with increased volume; at the end of the month, the market rose then fell back before the holiday, dominated by long-holiday risk aversion and profit-taking. Domestic policies intensively stepped up to stabilize growth, but the sustainability of the market repair was insufficient. By industry, real estate, pharmaceutical biology, and banks were relatively favored, while non-ferrous metals, power equipment, and machinery equipment adjusted significantly, and allocation tended toward defense and balance. Looking ahead to October, industry allocation recommendations mainly revolve around prosperity and performance catalysts: At the macro level, the domestic economy is improving marginally, with external demand and corporate capital expenditure constituting the main support, while domestic demand repair still needs policy promotion. Exports maintain strong resilience, technology industry demand and advanced manufacturing expansion drive production recovery, and the prosperity of manufacturing, construction, and small and medium-sized enterprises has improved somewhat; however, real estate, government spending, and household consumption remain weak, and aggregate improvement has not yet fully spread. On the price side, upstream price increases and the recovery of advanced manufacturing prosperity coexist, while terminal consumer price repair is relatively slow, reflecting insufficient demand and poor cost transmission, and corporate profit improvement remains structural. On the policy side, counter-cyclical adjustment is intensifying, with PSL expansion, increased relending quotas, housing loan interest subsidies, and accelerated fiscal fund disbursement advancing in coordination, which is expected to gradually improve domestic demand expectations by supporting project implementation and reducing financing and home purchase costs. On the external factor side, overseas tightening expectations are marginally cooling, which is expected to ease valuation pressure on A-shares, but long-end U.S. Treasury yields still constitute a constraint. U.S. growth resilience and inflation pressure coexist, and combined with fiscal sustainability concerns, long-end interest rates remain high, suppressing equity asset valuations. Recently, employment and core inflation data came in below expectations, and Fed officials' statements became more cautious, pushing market rate hike expectations lower. The bank believes there is a high probability of a rate hike pause in October, which is expected to reduce the suppression of tightening expectations on A-share valuations and risk appetite and support a phased repair. In addition, before the midterm elections, Trump's demands to stabilize the economy and capital markets, push down energy prices, and seek diplomatic achievements provide momentum for easing the U.S.-Iran situation. If substantive progress is made, it is expected to provide further support for A-shares by reducing oil price and inflation disturbances and improving global risk appetite. At the meso level: focus on areas with high growth or improvement in third-quarter earnings. October enters the third-quarter earnings disclosure period, and earnings clues become an important consideration for October industry allocation. 1) Industrial enterprise profits are narrowing, and overall third-quarter earnings improvement is expected to be limited. TMT and resource products remain the main support for growth, midstream manufacturing and optional consumption are improving marginally, and the pharmaceutical industry maintains relatively high growth. 2) Since August, earnings have been revised upward for electronics, non-bank finance, coal, pharmaceutical biology, basic chemicals, non-ferrous metals, real estate, petroleum and petrochemicals, etc. 3) The AI computing power chain, resource products, and some mid-to-high-end manufacturing industries are expected to continue leading in earnings growth, and areas where third-quarter earnings are expected to grow rapidly or improve are mainly concentrated in the AI industry chain (communication network equipment and devices, printed circuit boards, copper-clad laminates and upstream materials, memory chips, computing power chips, semiconductor packaging and testing, consumer electronics components and assembly, etc.), resource products (non-ferrous metals, petroleum and petrochemicals, coal, basic chemicals, etc.), mid-to-high-end manufacturing (marine equipment, construction machinery, general equipment, etc.), as well as pharmaceuticals, securities, textile manufacturing, etc. Prior performance, trading concentration, and monthly effects. 1) Over the past two months, the market shifted from earlier concentrated crowding to a more balanced style. Overall underperformance versus the Wind All A Index was mainly concentrated in some areas with relatively severe overcapacity, such as energy metals, batteries, construction machinery, photovoltaic equipment, and passenger vehicles; some industries that had fallen more earlier and are related to domestic demand began to outperform the market, such as decoration and furnishings, medical services, household products, breeding, and real estate. 2) Recently, market trading conditions have continued to diverge. The trading share of consumption/pro-cyclical areas such as baijiu, infrastructure construction, steel, cement, and hotels and catering is relatively low; the turnover share and turnover rate of medical services, wind power equipment, chemical pharmaceuticals, biological products, optical optoelectronics, general equipment, and communication equipment are at relatively high historical percentiles. 3) Every October, industries with a relatively high probability of excess returns are mainly concentrated in electronics, non-bank finance, and low-valuation areas, such as building decoration, transportation, pharmaceutical biology, and textiles and apparel. Combining multiple dimensions including meso prosperity, profitability, chip distribution, valuation, trading, cycle stage, and track value, October should downplay index fluctuations, focus on prosperity and performance, and at the same time use some domestic demand directions for balanced allocation. It is recommended to position around three clues, with key attention on: 1) performance realization directions in the AI computing power chain, such as electronics (semiconductors); 2) global capital expenditure and resource product directions, such as power equipment (batteries, grid equipment) and non-ferrous metals (industrial metals, precious metals); 3) low-valuation and domestic demand balanced directions, such as pharmaceutical biology, agriculture, forestry, animal husbandry and fisheries, and banks. Recommended Sub-sectors for This Period [Electronics (Semiconductors)]: AI capital expenditure continues to spread to wafer manufacturing, storage, and high-speed interconnect, and third-quarter earnings enter a concentrated verification period. 1) The global semiconductor expansion cycle is still rising, global semiconductor sales year-on-year growth continues to expand, and the sustainability of equipment demand is relatively strong. 2) Third-quarter earnings will become a key window to test performance realization. Continuous AI server volume growth drives demand for high-end PCB, CCL, AI power supplies, and high-speed interconnect, and promotes volume-price improvement in DRAM, NAND, and advanced packaging links, and industry profits are expected to continue growing rapidly. 3) Domestic substitution is advancing in depth from complete equipment to high-barrier components and materials. Links with lower localization rates and longer customer verification cycles have relatively greater growth space and profit elasticity. 4) On the industry catalyst side, TSMC confirmed price increases by process node and continued to raise equipment procurement quantities, advanced packaging supply and demand remain tight, and prices and capital expenditure resonate. [Power Equipment (Batteries, Grid Equipment)]: Batteries have entered a stage of production scheduling and profit repair, while computing power load growth, energy transition, and grid renewal jointly open up medium- to long-term demand space for grid equipment. 1) On batteries, production scheduling continues to improve month-on-month, power batteries, energy storage batteries, and some material links still maintain relatively rapid year-on-year growth, and third-quarter industry profits are expected to continue repairing. 2) At the technology and policy level, the national plan for new-type batteries proposes goals such as initially achieving large-scale application of all-solid-state batteries. The industry will shift from single-route competition to coordinated development of lithium, sodium, solid-state, and flow batteries, and equipment, solid-state electrolytes, and high-safety materials have medium- to long-term incremental potential. 3) The certainty of grid equipment is relatively higher. A large number of new energy and data center projects are constrained by grid access capacity. Computing power load growth will promote ultra-high-voltage expansion and distribution network intelligence, and transformers, switchgear, secondary equipment, and energy storage PCS are all expected to benefit. [Non-ferrous Metals (Industrial Metals, Precious Metals)]: Industrial metals benefit from expanding emerging demand while supply is constrained, and precious metals continue to benefit from central bank gold purchases, overseas macro landing, and geopolitical risks. 1) The core contradiction for copper is shifting from traditional real estate demand to supply constraints and new demand expansion, and profits may concentrate toward the resource end and high-value-added copper material links. 2) For aluminum, the domestic capacity ceiling constraint is clear, industry operating rates are relatively high, and demand from power grids, new energy vehicles, photovoltaics, and packaging provides support. Combined with overseas production cuts caused by Middle East geopolitical disturbances, the price center is expected to be supported. 3) The medium- to long-term logic of precious metals has not yet been broken. Global central bank net gold purchases have increased year-on-year, and reserve diversification and geopolitical risks still constitute bottom support for gold prices, but in the short term attention needs to be paid to changes in the dollar, real interest rates, and ETF flows. 4) On profitability, copper and gold resource companies benefit from the rise in metal price centers, and third-quarter earnings are expected to continue growing rapidly; electrolytic aluminum companies' per-ton profit and cash flow are expected to remain high. [Pharmaceutical Biology]: Innovative drug overseas expansion and CXO order recovery form an industry resonance, and pharmaceutical industry profits are expected to continue recovering. 1) On the policy side, the "15th Five-Year Plan for Pharmaceutical Industry Development" proposes goals such as the scale of the innovative drug industry and R&D investment intensity. The lower bound of R&D investment is raised, which is conducive to demand expansion for innovative drugs, clinical services, CDMO, and scientific research upstream. 2) On the overseas expansion side, global pharmaceutical companies have begun systematically purchasing Chinese assets. Recently, expectations of geopolitical restrictions on BD have eased, and overseas licensing is expected to continue booming. 3) On the performance side, the market is about to enter the third-quarter earnings expectation trading window, and the market pricing logic is shifting from "valuation-driven" to "profit verification." New product volume growth, BD revenue recognition, and the recovery of the innovative drug industry chain are expected to drive further improvement in pharmaceutical profits. 4) On industry catalysts and events, Xi'An International Medical Investment conferences are, and potential data readouts and licensing cooperation may form catalysts. [Agriculture, Forestry, Animal Husbandry and Fisheries]: Climate disturbances raise the price elasticity of the planting chain, the industry supply-demand structure continues to improve, and profits are expected to recover cyclically. 1) On the planting chain, El Nio has been confirmed and will strengthen into a super event. The impact of abnormal climate on Shenzhen Agricultural Power Group prices usually has a time lag, and tighter supply expectations are expected to push the price center of related varieties upward. 2) On seed industry, food security, agricultural subsidies, and industrialization of biological breeding constitute medium-term support. As third-quarter pre-sales gradually start, if grain prices and planting returns improve, seed demand, pricing ability, and channel collections are expected to repair simultaneously. 3) On hogs, hog and piglet prices have fallen year-on-year, supply pressure has not yet fully eased, and low hog prices will further test the cash flow of high-cost breeding entities. The industry investment logic is shifting to "deepening losses-capacity reduction-supply-demand rebalancing." [Banks]: Real estate policy support and fiscal-financial coordination improve asset quality expectations, and the value of high-dividend allocation is reflected. 1) Banks' relative advantage comes from dividend certainty. At a stage when market volatility increases and technology growth is relatively crowded, stable cash flow and lower PB can attract medium- to long-term funds such as insurance, wealth management, and ETFs. 2) The impact of the real estate policy combination on banks is generally positive. Housing loan interest subsidies are borne by fiscal authorities, which helps reduce residents' home purchase costs without directly compressing bank loan returns; PSL rate cuts and expanded relending tools are conducive to ensuring that affordable housing, urban renewal, and real estate inventory acquisition projects obtain medium- to long-term funds. 3) On the performance side, if lower deposit costs can partially offset the decline in loan yields, combined with stabilizing non-performing loan generation rates, bank profit growth may gradually bottom out. Sub-sector Prosperity Review and Outlook Meso indicators and prosperity indices show that areas currently with relatively high prosperity or marginal improvement are mainly concentrated in some mid-to-high-end manufacturing and some consumption areas such as military electronics, batteries, computer equipment, breeding, household appliances, and chemical fibers. Upstream Resource Products: Supply constraints for steel and coal are strengthening, and geopolitical disturbances support upward oil prices. Traditional peak-season steel demand is expected to improve, and steel prices are expected to fluctuate and repair; restocking combined with the start of winter storage, rigid demand is expected to support coal prices at high levels; petroleum and chemicals may continue high-level fluctuations with structural divergence, and upstream oil and gas, refining, and refrigerants are relatively favored; non-ferrous prosperity may maintain high-level fluctuations and structural divergence, with copper, aluminum, and strategic minor metals relatively favored, and precious metals maintaining resilience. Midstream Manufacturing: Domestic and external demand divergence continues, and overseas expansion and high-end equipment prosperity improve. Photovoltaic supply clearance and price repair still need time to verify, and energy storage orders and "Golden September and Silver October" stocking are expected to support continued positive growth in lithium battery production scheduling; in military industry, global arms restocking demand continues to be released, and air defense, missile defense, and high-consumption weaponry are expected to maintain high prosperity; in machinery, construction machinery exports maintain resilience, domestic demand continues to decline, and demand for automation and high-end equipment grows rapidly; in automobiles, exports remain the main support, and the new car cycle is expected to be concentratedly realized. Consumption/Pharmaceuticals: Terminal demand remains weak, and the double festivals catalyst combined with "Double Eleven" pre-sales is expected to boost consumption in the short term, while innovative drug prosperity continues. Post-real-estate-cycle consumption is still mainly driven by stock renewal and policy; National Day banquets and gift-giving demand are expected to drive further improvement in the sell-through of baijiu, dairy products, and leisure foods, but it will still mainly be a structural recovery; optional consumption continues to diverge, beauty makeup is expected to be boosted by "Double Eleven" pre-sales, and gold jewelry is more dependent on gold price stabilization; service consumption remains a direction with relatively high certainty; innovative drugs and related CXO are expected to maintain prosperity, and the sector will further concentrate toward companies with core pipelines and realization capabilities. Finance and Real Estate: The real estate policy "combination punch" has landed, bank net interest margins are stabilizing, and non-bank prosperity is diverging. Real estate is closer to "sales stabilizing first, investment still lagging," and "Golden September and Silver October" transactions are expected to improve in stages; banks continue "slower scale growth, stabilizing net interest margin, and moderate profit repair"; securities firms' prosperity is declining and industry divergence is intensifying, while insurance value rate improvement is expected to support valuation, but it is still constrained by low investment returns. Information Technology: AI computing power and storage demand remain strong, price increases continue to spread, and hardware-side performance is expected to continue growing rapidly. In electronics, AI computing power capital expenditure and storage price increases remain the two main mainlines, and domestic semiconductor prosperity continues to rise; in communications, optical interconnect and AI network upgrades remain the core DRIVE; in computers, priority should be given to directions where AI revenue begins to be realized; in media, AI applications and overseas expansion remain the main sources of elasticity. Multi-dimensional Review [Profitability] From the distribution of historical ROE percentiles, directions such as non-bank finance, communications, and non-ferrous metals rank among the top in profitability. Insurance, communication equipment, and industrial metals ROE percentiles are at historical highs, while minor metals, consumer electronics, and batteries are also at relatively high percentiles; real estate, decoration and building materials, household products, infrastructure construction, banks, baijiu, household appliances, photovoltaic equipment, wind power equipment, and passenger vehicles have ROE percentiles at historical lows. The industrial metals and batteries recommended in this period rank high in ROE percentile, with relatively strong profit-side support. [Earnings Expectations] As the third-quarter earnings disclosure window approaches, over the past month analysts' consensus earnings expectations for some industries have been revised upward, including energy metals, chemical fibers, decoration and furnishings, semiconductors, chemical raw materials, commercial retail, and medical services; consensus earnings expectations for some industries have been revised downward, with relatively large downward revisions for biological products, airports, cement, photovoltaic equipment, breeding, software development, and passenger vehicles. [Chip Distribution] In the second quarter, public funds mainly increased positions in semiconductors, communication equipment, general equipment, consumer electronics, special equipment, automation equipment, minor metals, and computer equipment. Industries with relatively high position ratios mainly include semiconductors, communication equipment, batteries, chemical pharmaceuticals, baijiu, and securities; this month, margin funds increased positions in communication equipment, general equipment, special equipment, auto parts, wind power equipment, insurance, and batteries. From the perspective of the percentile over the past ten years, the public fund position ratios in industries such as semiconductors, communication equipment, general equipment, special equipment, automation equipment, minor metals, and chemical fibers are above the 80th percentile. [Valuation Level] Currently, many industries have valuation percentiles at highs over the past ten years. The PETTM percentile of automation equipment is above 90%, and breeding, general equipment, communication equipment, military electronics, wind power equipment, coal, cement, decoration and furnishings, steel, and household products are above 80%; securities, insurance, industrial metals, batteries, condiments and fermented products, hotels and catering, beauty care, computer equipment, baijiu, and energy metals have percentiles below 20%, among which insurance, banks, infrastructure construction, securities, industrial metals, shipping ports, and household appliances have PETTM absolute levels in the lowest tier of the entire market, with relatively sufficient margin of safety. Compared with the recommendations in this period, batteries and industrial metals have low valuation percentiles, and banks have absolute valuations in the lowest tier. [Trading Analysis] In September, market trading activity declined somewhat, and turnover in previously crowded areas fell back marginally. Industries whose turnover rate percentile in this period is at a medium-to-high level and in an upward trend mainly include passenger vehicles, military electronics, general equipment, and chemical products. Industries with relatively high trading concentration in this period and in an upward trend mainly include wind power equipment, medical services, optical optoelectronics, general equipment, and semiconductors. [Cycle Stage] At present, the domestic economy overall shows a weak repair pattern, the pace of domestic demand recovery is relatively slow, external demand is relatively strong, old and new growth drivers continue to diverge, and the slope of aggregate fundamental repair is relatively moderate. However, market liquidity maintains a reasonably accommodative environment, policy support continues to intensify, and combined with the steady advancement of industrial upgrading trends, A-shares as a whole are in a cycle transition stage from valuation repair to profit verification. From a medium- to long-term perspective, technological innovation remains the core growth mainline; at the same time, attention can be paid to areas with high export growth and domestic demand repair, thereby balancing fluctuations in the technology sector. [Track Value] From a short-term perspective, in October focus on five tracks with marginal improvement: domestic computing power, overseas computing power, innovative drugs, Siasun Robot&Automation, and non-ferrous metals. From a medium- to long-term perspective, it is recommended to take the cycle as the axis and supply-demand as the anchor, and pay attention to the progress of society-wide intelligence under the new technology cycle, the independent controllability of related industry chains under the domestic substitution cycle, cost reduction and efficiency improvement across the entire carbon neutrality industry chain under the "dual carbon" cycle, and the increase in penetration rate of electric intelligent vehicles under the major trend of electrification and intelligence. Risk: Industry support less than expected, macroeconomic fluctuations.