How to cope with high interest rates? CITIC SEC: Allocate to booming sectors and varieties with supply cleared.

CITIC SEC released a research report stating that stabilizing oil prices, non-farm payroll data below expectations, and downward revisions to Federal Reserve rate hike expectations have all failed to change the rise in global long-term bond yields. The reason behind this is persistently strong private-sector investment and financing demand. Driven by trillion-dollar investment, North America has taken the lead in emerging from the "abnormal state" of low growth and low interest rates after the financial crisis. The global high interest rate environment, before the inflection point of the AI investment cycle, is a normal state that must be coped with. The only demand insensitive to overseas high interest rates lies in North American AI and areas related to China's central fiscal expansion, while the overseas expansion and resource sectors that delivered excellent holding experience in past years are both under pressure. In a weak demand environment, the scarcity of varieties with supply cleared is highlighted, and the anti-involution process still deserves attention next year. In terms of allocation strategy, in the short term, only booming varieties and supply-cleared varieties can be used to cope with the high interest rate environment. It is recommended to closely track the inflection point of the AI investment cycle. The main views of CITIC SEC are as follows: Stabilizing oil prices, non-farm payroll data below expectations, and downward revisions to Federal Reserve rate hike expectations have all failed to change the rise in global long-term bond yields. Compared with the oil price shock phase in the first half of the year, current crude oil prices are closer to repeated fluctuations at high levels. The implied inflation rate of the U.S. 10-year TIPS has basically remained around 2.35% since early September, with the current reading at 2.33%. Recent oil price volatility has not yet pushed long-term inflation expectations further higher, and inflation expectations are not the main factor behind this round of long-end rate increases. U.S. September non-farm payrolls added only 29,000 jobs, below the expected 90,000, while average hourly earnings rose only 0.1% month over month, below 0.3% in August, with year-over-year growth falling to 3.0%, continuing to hit a new low since 2020. A series of weaker employment and inflation data significantly revised down the market's expectations for Federal Reserve rate hikes. The probability of a Federal Reserve rate hike in October implied by interest rate futures fell sharply from 64.2% on September 25 to 17.7% on October 8. However, these factors did not lead to weaker long-end government bond yields. Recently, 10-year government bond yields in the United States, Japan, and the United Kingdom respectively touched highs since 2002, 1996, and 2007, while Germany and Australia rose to highs since 2011. The U.S. dollar index continued to strengthen, rising from 99.7 on September 1 to 102.1 on October 8, breaking above the upper bound of its trading range since the end of April 2025. The largest recent pullback in long-term bond yields occurred when OpenAI's ARR was significantly below market expectations (early morning Beijing time on October 9), triggering market concerns about the sustainability of future AI capital expenditure. This shows that the most important part of current long-term bond yield pricing is still expectations for the AI investment cycle, rather than short-term inflation and monetary policy direction. Driven by trillion-dollar investment, North America has taken the lead in emerging from the "abnormal state" of low growth and low interest rates after the financial crisis. 1) Over the next year, high long-end bond yields may be the norm. Net financing by U.S. non-financial corporations from the second half of 2025 to the first half of 2026 reached $825.521 billion, an increase of 16.1% compared with the full year of 2025. At the same time, corporate net purchases of government bonds fell from $107.878 billion in 2024 to $12.969 billion in 2025, and even turned to net selling from the second half of 2025 to the first half of 2026. The private sector is both intensifying competition on the funding demand side and reducing its absorption on the government bond demand side. This is the essential reason why current long-term bond yields remain high. As long as AI investment and corporate financing demand do not cool substantially, pressure on long-term funding supply and demand will be difficult to ease significantly. If the year-over-year growth portion of AI Capex in 2027 (market consensus of roughly more than $400 billion) needs to rely entirely on private-sector debt financing, then government bond yields will rise further. But high interest rates do not simply signal a major stock market correction. In particular, one should not directly compare the stock market's "E/P" with the 10-year government bond yield to judge the relative attractiveness of stocks and bonds. The difference between the S&P 500 earnings yield and the 10-year U.S. Treasury yield was called the "FED Model" in the 1990s and is often used to measure the relative attractiveness of stocks and bonds. Empirically, a large body of research has proven that the spread between the two has no predictive power for stock market returns. The predictive power of "E/P minus 10-year rate" is far weaker than that of "E/P" itself. In other words, historically, stock market correction pressure has come from bubbles in their own valuations, rather than capital crowding out caused by stock-bond comparisons. 2) The core of predicting the direction of long-end rates is to closely track the inflection point of this round of the AI investment cycle. The cloud business profit margin of core CSPs and computing power rental prices are the true forward-looking indicators. High interest rates do not mean that equity markets have lost room to rise. If AI commercialization still fails to achieve greater breakthroughs, or the process of connecting with the physical world falls short of expectations, a weakening AI investment cycle will deal a major blow to equity markets, mainly reflected in substantial downward revisions to earnings expectations. Conversely, as long as the intensity of AI investment continues, elevated long-end rates should be regarded as a normal state that needs to be adapted to for some time, and should not become a reason to passively turn bearish on equity assets. But if massive AI investment repeatedly fails to a leap in productivity or corresponding incremental commercial space, this state will be difficult to sustain over the long term. At that point, the end of the AI investment cycle may be accompanied by a new round of global economic adjustment and a collective clearing out of risk assets. Companies will reduce investment, financing demand will decline accordingly, and demand for global safe assets such as government bonds will recover, thereby driving long-end rates lower. The most effective forward-looking indicators for predicting the inflection point of the AI investment cycle should be the cloud business profit margin of core CSPs and computing power rental prices, representing the balance of real-world computing power supply and demand. These are the true risk indicators. Long-end bond yields are more a result of investment and financing behavior. The only demand insensitive to overseas high interest rates lies in North American AI investment and China's central fiscal expansion, while overseas expansion and resources are both under pressure. 1) North American AI and China's "six networks" construction are among the few directions that can withstand high interest rates in the future. In the current high interest rate environment, the directions globally that can still bear such rates and still grow are almost only the trillion-dollar-level real investment in North American AI infrastructure. If the AI infrastructure investment cycle begins to slow, it will be very difficult for growth in other global areas to offset downward pressure. Therefore, from the perspective of global capital markets, in an environment of extremely high interest rates, the sector that may continue to rise late in the bull market and only correct at the end may be AI alone. But if looking only at China's capital market, the situation is somewhat special. China's abundant savings and capital keep it in the position of a global interest rate lowland. Private-sector willingness to invest and borrow is relatively weak, but central fiscal expansion has huge space and flexibility, and can better utilize the current abundant capital dividend. Considering policy tone and the philosophy of fiscal expansion, among directions that are domestic-demand-oriented and rely on debt financing, the new infrastructure represented by the "six networks" currently appears the most feasible. It is estimated that during the "15th Five-Year Plan" period, the total upstream and downstream investment scale driven by the "six networks" is expected to reach RMB 53-72 trillion. In terms of pace, it will accelerate in 2027, with 2028 possibly being the peak during the period. Correspondingly, the peak revenue realization for listed companies is expected in 2027-2028, and the prosperity of general equipment, electrical equipment, and computing power ICT hardware may be relatively high overall. 2) The overseas expansion and resource sectors, which delivered excellent holding experience in past years, may come under pressure in a future environment of persistently high interest rates. The overseas expansion sector will face the potential squeeze on non-AI demand from a high interest rate environment in the future, while geopolitical issues may create additional trade friction costs, and a strong renminbi may generate sustained exchange losses. Recent China-EU economic and trade consultations made some better-than-expected progress, at least avoiding direct trade friction on the hybrid vehicle issue, but over the weekend the United States launched another Section 337 investigation. Similar events usually do not directly damage companies' current revenue and profit, but they continuously suppress valuations. The problem for the resource sector is more direct. High real interest rates directly suppress the financial attribute premium of resource products, while the rise in overall industrial costs to some extent also restrains demand for upstream resource products from non-AI industries. With ROE at high levels and Chinese companies' willingness to expand production and invest overseas rising, even a quarterly-level commodity price adjustment may bring relatively large drawdowns to resource stocks and reduce holding experience, while holding experience was precisely one of the greatest advantages of resource stocks in the past. A weak demand environment highlights the scarcity of supply-cleared varieties, and the anti-involution process still deserves attention. China's 10-year government bond yield fell from 3.63% in early 2015 to 1.69% on October 8, 2026, while the weighted average interest rate on corporate loans also fell from 4.64% in early 2020 to the latest 3.04%. At the same time, in the first eight months of 2026, private investment and manufacturing investment fell by 10.1% and 2.3% year over year, respectively. Lower financing costs have not yet brought about a broad return of investment expansion. This means that companies' operating focus is still biased toward stock adjustment, preferring to protect cash flow and digest existing debt rather than expand investment through new leverage. Therefore, industries with continuously contracting capital expenditure but gradually recovering profit margins deserve more attention. Supply constraints in some industries also make the competitive position of advantageous companies more prominent. Therefore, anti-involution still deserves attention, but the allocation focus should shift from policy expectations to financial realization of improved competitive landscape. Data from the 2026 interim reports show that among 79 CITIC third-tier non-financial industries with total market capitalization of no less than RMB 300 billion, 24 industries simultaneously experienced capital expenditure contraction and gross margin recovery, of which 14 maintained this characteristic for at least three consecutive quarters. Although capital expenditure contraction cannot yet be directly equated with permanent capacity exit, sustained investment restraint and recovering profit margins have provided important clues for identifying directions with improved supply landscape and strengthened competitive advantages. In manufacturing, anti-involution in chemicals, photovoltaics, lithium batteries, automobiles, and auto parts has entered deep water and the verification stage, with next year being the most important window. In services and distribution, platform economy, chain retail, express logistics, and hotels are also worth close tracking. Use prosperity and supply clearing to cope with high interest rates, and closely track the inflection point of the AI investment cycle. We remain optimistic about the market attack window around the third-quarter earnings season, and high interest rates will not hinder or affect the realization of this judgment. North American AI investment has relatively strong demand support and financing capacity, making it the most resilient link in this round of global prosperity. A sustainable market attack cycle cannot do without AI participation. However, considering that the pace of AI commercialization is still slow relative to the huge investment scale, capital scarcity may constrain the ceiling of annual AI capital expenditure after 2028, causing valuations across the AI hardware sector to be suppressed. Therefore, future offensive opportunities in AI may be more concentrated in new technologies and new themes supported by the logic of "product iteration under the same capital expenditure," while traditional institutional heavyweights may have more structural repair opportunities during earnings season. Before an inflection point appears in the AI investment cycle (with key focus on CSP cloud business profit margins and computing power rental price trends), such market moves are expected to play out repeatedly. In terms of allocation strategy, focus on North American AI, China's "six networks" construction, and supply-cleared varieties driven by anti-involution. The AI plus energy and chemicals structure remains applicable in the current high interest rate environment. Within the technology sector, pay attention to optical communications, PCB, MLCC, gas turbines, wafer manufacturing, etc., with particular emphasis on new technologies and new themes. For non-technology sectors, focus on increasing allocation to energy and chemicals, innovative drugs, dividend plays (coal, banks), and leading brokerages with overseas expansion potential. Risk factors Intensified friction among China, the United States, and other parties in technology, trade, and finance; domestic policy intensity, implementation effects, or economic recovery falling short of expectations; domestic and overseas macro liquidity tightening more than expected; further escalation of conflicts in Russia-Ukraine, the Middle East, and other regions; China's real estate inventory digestion falling short of expectations.