CITIC SEC: Structural turning points in the market are increasing in 2027; K-shaped convergence and broader market breadth may be the most important features.

CITIC SEC released a research report stating that the market adjustment has already occurred earlier this year, and structural turning points are increasing next year. The previous thinking that "industry trend decline = bull turns to bear" no longer applies to this round of AI industry; AI is still in its early development stage, and in the short term it generates mostly negative externalities for other economic sectors, causing prices of various consumer goods production materials to surge, siphoning funds from the bond market and pushing long-end interest rates sharply higher, which suppresses non-AI demand, while Agents to some extent also crowd out employment. The intersection of these problems has produced severe economic and market divergence. In the strongest phase of the AI bull market, non-AI sectors have generally already entered a downtrend ahead of time and experienced deep valuation adjustments. But precisely because of this, if AI investment slows its growth pace in the future, the bank has no reason to remain pessimistic on non-AI sectors. If AI enters a consolidation period, non-AI sectors are expected to see a turning point; falling interest rates, falling materials prices, and policy rebalancing are all conducive to making the market more balanced. "K-shaped convergence and broader market breadth" may be the most important market features of 2027. The bank expects divergent trends within the technology sector, broad structural repair opportunities in non-AI sectors, and that the main process of valuation contraction was completed in 2026. Clearing in the capital landscape takes time, and investors will also gradually return to reasonable return expectations. Stable-return strategies represented by PB-ROE are more advantageous than prosperity strategies, and there may be a major style shift. In allocation, diversification is needed, responding along four threads: stable returns, excellent overseas-expanding manufacturing, domestic demand repair, and new AI technology themes. CITIC SEC's main views are as follows: Market features: K-shaped convergence, broader market breadth. 1) This year global major stock markets all experienced historically rare structural divergence. Since 2026, market breadth in global stock markets has generally narrowed, with AI and non-AI sectors showing clear divergence. In the four markets of China, the US, Japan, and South Korea, the excess return of the AI core portfolio relative to the non-AI core portfolio reached about 30% during the year (as of October 22), at one point reaching 150% at the peak. The market's direction deviated markedly from expectations at the start of the year in two ways. First, the bank could hardly have anticipated that, with the rapid expansion of AI investment, AI hardware would in the short term generate substantial negative externalities for other economic sectors, causing prices of various consumer goods production materials to surge, siphoning funds from the bond market and causing overseas government bond yields to soar, ultimately making the extreme degree of market divergence far exceed expectations. Second, the bank could hardly have anticipated that sectors constituting market breadth and, such as overseas expansion and resources, would encounter various valuation-suppressing factors this year. Market expectations shifted from Fed rate-cut expectations at the start of the year to rate-hike expectations, China-Europe trade frictions heated up rapidly, and RMB appreciation was much faster than expected and caused huge exchange losses. Under the interweaving of these factors, the market's expectations for high-prosperity sectors such as overseas expansion and resources shifted from optimism at the start of the year to the current pessimism, and dynamic valuations compressed substantially. Under such a huge expectation gap, the market rarely saw a broad decline in a year of rapidly rising profit growth. Investors currently have generally cautious attitudes toward both AI and non-AI, very different from the start of the year. 2) Looking ahead to 2027, the AI industry trend is still upward, but stock momentum may weaken. The probability that AI hardware becomes the market's core thread for a fifth consecutive year is declining. Based on the current market's neutral expectations for the AI capex path, the bank estimates that by 2030 the external direct charging revenue required from terminal AI applications should reach US$2.75 trillion to achieve reasonable and sustainable capital returns across the entire industry chain; relying only on frontier model companies would be far from enough. If no new scenarios capable of generating huge commercialization space emerge (such as physical AI), then existing model applications extended based on Agents will either gradually become embedded as part of corporate IT budgets and gradually integrate into corporate business processes, or become a cost for C-end platforms to increase user retention time and acquire traffic entry points (for example, AI short dramas' consumption of computing power). These are more like cost items than revenue-generating items. This means AI investment may continue, but single-year investment intensity may decline, gradually evolving into a purer infrastructure construction process. From the perspective of stock elasticity itself, assuming global AI capex reaches US$1.6 trillion in 2030, the bank estimates that for A-share + Hong Kong AI hardware industry chain companies, based on 15x PE in 2030, market cap would be about 51% higher than current, and overall compound returns are no longer attractive, requiring selection of Alpha. In addition, institutional holdings in AI remain relatively high, which will constrain the sector's ability to continue attracting incremental funds. 3) Non-AI expectations are extremely low, but potential marginal improvement factors are increasing. Several main factors suppressing overseas non-AI demand may not get worse in 2027. First, the overseas high-interest-rate situation may ease. It is expected that as North American AI investment slows in the next two years, private-sector debt financing scale will peak and decline, weakening the crowding-out effect on government public-sector financing, improving supply and demand in the government bond market, and driving long-end rates lower. Second, the pace of RMB appreciation may slow, and exchange losses will decrease year on year. The bank estimates that when the USD/CNY exchange rate is in the 6.35-6.65 range, the impact of exchange losses on the net profit growth of all-A non-financial companies is 0.5%-6.2%, while in the first half of this year it reached 7.3%. Third, if the Democratic Party successfully wins the US midterm elections, the Middle East situation and oil prices may also improve, easing inflation and rate-hike anxiety and also easing currency depreciation pressure in non-US countries. As for non-market factors, especially the heating up of China-Europe trade frictions, we believe that in the long run it is difficult to block the process of excellent Chinese manufacturing companies going overseas; and factors such as export controls on key technologies and equipment and cuts in export tax rebates, although creating short-term pressure on the industry, are crucial for clearing out low-quality enterprises and stabilizing supply-demand patterns and niche markets, and in the long run are very favorable for companies that operate compliantly and have already made full preparations for overseas expansion. For domestic demand, policy is an economic reaction variable that is difficult to predict. When the overall economy weakens and micro-entity confidence is sufficiently low, we can often still see policy intensity increase. This year, apart from the special circumstances of 2021 and 2023, is a historically very rare year of year-on-year contraction in the fiscal deficit, with tax revenue growing above expectations while expenditure progress has consistently fallen short of expectations; perhaps next year some adjustments will be made to micro implementation processes. Considering that more than half of this year's export growth was contributed by price increases in AI-related goods (volume was basically flat), nominal export growth will face greater pressure to slow next year, which may also provide some reason for domestic demand policy to step up. Of course, the most favorable aspect for non-AI sectors is that expectations are low enough, especially for overseas-expansion sectors. For example, valuation percentiles for home appliances, consumer electronics, textiles and apparel, commercial vehicles, and medical devices are basically near historical extremes, and marginal better-than-expected improvement in macro factors may bring sufficient return elasticity. Earnings trend and valuation: growth may slow in 2027, but the main process of valuation contraction has been completed this year. 1) All-A non-financial earnings growth is expected to slow somewhat in 2027. Entering 2027, the profit base for technology and cyclical sectors rises markedly; even if prosperity remains high, the boost to overall earnings growth will weaken. At the same time, easing exchange-rate pressure for overseas-expanding companies, improvement in overseas demand, and stronger central fiscal support for domestic demand and the disappearance of the impact of fading consumption subsidies are expected to make growth sources more diversified. The bank expects all-A attributable net profit to grow 15.5% and 9.5% year on year in 2026 and 2027, respectively, and all-A non-financial attributable net profit to grow 20.1% and 14.7%. Full-year earnings will still grow, but the incremental structure will gradually shift from concentrated contribution by a few high-prosperity industries to support from continued technology growth, overseas-expansion repair, and reduced domestic-demand losses. Specifically: 1) Cyclical sectors: nonferrous metals digest a high base, energy and chemicals provide earnings support; attributable net profit growth is expected to reach 45.5% and 9.8% year on year in 2026 and 2027, respectively; 2) Technology sector: the industry chain continues high growth, but growth slows under the influence of a high base; earnings growth is expected to be 101.9% and 43.0% year on year this year and next; 3) Overseas-expansion sector: easing exchange-rate pressure and improved overseas demand drive full-year earnings repair; earnings growth is expected to be -0.5% and 8.8% year on year this year and next; 4) Domestic-demand sector: stronger central fiscal support is the core variable for earnings to stop falling and rebound; earnings growth is expected to be -14.4% and 8.8% year on year this year and next; 5) Financial sector: non-bank profit growth returns to normal, banks remain stable; earnings growth is expected to be 11.5% and 4.6% year on year this year and next. 2) But the valuation contraction process for most sectors has basically been completed this year. As of October 23, 2026, the technology sector has completed the first wave of valuation de-rating after the "second derivative" downward revision. The 15 most core AI stocks have adjusted for 77 trading days since July, falling as much as 44.5% at the worst point, while the 200 stocks heavily held by institutions fell as much as 35.8%, already exceeding the decline of core stocks during the collapse of the new energy crowding-in trade from December 2021 to the end of April 2022. At that time (December 17, 2021 to April 26, 2022), the 15 core new energy stocks fell 40.9%, and the 200 institutionally heavily held stocks fell 33.7%. From a global comparison perspective, US and Japanese non-AI leaders are at historically high valuations, while A-share non-AI is below the median. The bank uses AI and non-AI leader baskets from the four markets of China, the US, Japan, and South Korea, calculates PE (TTM) using the aggregate method, and makes cross-market comparisons. As of October 22, 2026, A-shares are the only market where the AI valuation premium relative to non-AI remains above the historical center: the AI/non-AI PE multiple is 4.4x, at the 82nd percentile since 2016; the same multiple in the US, Japan, and South Korea has fallen to the 1st, 17th, and 24th percentiles, respectively. The PE of US and Japanese non-AI non-financial leaders is 33.5x and 23.0x, at the 98th and 95th percentiles; the PE of A-share non-AI non-financial leaders is only 15.6x, at the 21st historical percentile, with consumer, manufacturing, and pharmaceutical leaders at only the 12th, 1st, and 3rd historical percentiles, respectively. 3) From the perspective of shareholder returns, A-shares have made substantial progress compared with the past. Although various types of equity financing in the technology sector reached RMB246.5 billion this year (already 2.2x that of 2025), cash returns and buybacks for the market as a whole, especially non-technology sectors, continued to hit record highs. This year, as of October 23 (same below), against the backdrop of concentrated listings of technology companies, A-share dividends and buybacks combined were 3.4x equity financing (5.1x in 2025 after excluding special treasury bond capital injections into major state-owned banks, and 10.6x in 2024 due to the temporary tightening of IPOs and refinancing). By comparison, the US stock market is rapidly transforming from a past net shareholder-return market into a financing market. Federal Reserve Z.1 data show that net issuance of equities by the US non-financial corporate sector (seasonally adjusted annualized) was negative in all four quarters of 2025, turned to +US$181.4 billion in Q1 2026, and rose further to +US$607.8 billion in Q2, the highest single quarter since 1990. If (cash dividends + buybacks equity financing) average total market cap is used to measure the net cash return rate to shareholders, it can be seen that in recent years the S&P 500's net cash return rate fell from 4.6% in 2016 to 2.5%, and for US AI leaders it is only 0.81%. A-shares are moving in the opposite direction: equity financing is decreasing, dividends and buybacks are rising, and the all-A net cash return rate rose from -1.5% in 2016 to 2.5% in 2024; it was 2.1% in 2025 and 1.4% year to date this year. Capital landscape and style: clearing in the capital landscape takes time; stable-return strategies represented by PB-ROE are more advantageous than prosperity strategies, and there may be a major style shift. 1) The capital ecology needs time to recover, and investors are returning to reasonable expected returns. In terms of market capital landscape, the bank expects the retail incremental process to slow markedly. After a new round of severe drawdowns, active equity funds have again fallen into the cycle of "larger redemptions as NAV rebounds." Sector ETFs, private quantitative funds, and long-term funds will constitute the main incremental capital for the market in the future, and the influence of "long money" in the market continues to rise. But at the micro level, under the multiple influences of quarterly and annual assessments, unstable liability sides, solvency constraints, and drawdown stop-loss mechanisms, some formal "long money" such as annuities has also shown some short-term behavior. The key to repairing the capital ecology is not just the rise in the absolute scale of a certain type of institution, but the re-matching of liability-side stability, assessment horizons, and trading behavior. Before this process is complete, the market may still focus more on short-term capital behavior and dare not easily price for the long term. After experiencing this year's extremely high abnormal return elasticity and severe market adjustment, investors are expected to gradually return to reasonable return expectations, using moderate position levels and stable-return holdings to get through the stage of capital clearing and investor confidence recovery. 2) Stable-return strategies will clearly prevail, with supply logic surpassing demand logic as the main factor. From the characteristics of A-shares, when demand clues are unclear, momentum and prosperity strategies enter a weak phase, and rotation accelerates markedly, stable-return strategies represented by PB-ROE will clearly prevail. Of course, static high-ROE or high-dividend-yield strategies have not historically performed excellently, and stable-return industries differ greatly across stages, requiring subjective judgment to find varieties with room for improvement in profitability or dividend capacity in the future. Backtest results show that a PB-ROE strategy incorporating distress-reversal elements clearly outperforms a simple PB-ROE strategy and is relatively stable across different market environments, especially when momentum strategies fail. The bank believes that two types of industries currently meet this framework for 2027. One is varieties with high dividend yields and stable profit growth next year, such as white goods, textiles and apparel, food seasoning, and thermal power. The other is varieties with supply-clearing potential logic, such as oil shipping, express delivery, leading property developers, some lithium battery materials, and midstream petrochemical segments. Industry allocation: moderately diversify, responding along four threads. Industry allocation in 2027 should be moderately diversified, positioned along four threads: stable returns, excellent overseas-expanding companies, domestic demand repair, and new AI technologies. Stable returns should start from improved supply patterns and sustainable capital returns, positioning around energy and chemicals, oil shipping, highways, logistics, white goods, pharmacies, insurance, overseas-expanding brokers, and financially sound property leaders. Excellent overseas-expanding companies should focus on ships, diesel engines, two-wheelers, CXO, power tools, power equipment, and other directions, capturing opportunities from slower RMB appreciation, improved overseas demand, and rising global share of Chinese companies. Domestic demand repair is premised on stronger central fiscal support. If there are better-than-expected policy changes, offensive varieties suggested for attention include restaurant supply chains, airport duty-free, health products, and medical device leaders, preferably companies able to capture demand improvement and raise market share. For new AI technologies, considering that some institutionally heavily held varieties still need to digest positions, focus on structural opportunities with clear application prospects and earnings delivery capability, watching passive optical components, PCB, storage, semiconductor equipment and materials, Siasun Robot&Automation, and edge AI. Combined with recommendations from the industry teams, the bank selected 15 companies around each of the four threads to construct corresponding portfolios. The market adjustment has already occurred earlier this year, and structural turning points are increasing next year. After a broad decline, there is no bear marketat least it is a structural market. As of October 23, 2026, 4,284 A-share stocks recorded negative returns, accounting for 76.8%, a relatively rare broad-decline year. Historically, after the share reform, A-shares have rarely seen such a high proportion of declines for two consecutive years (2017 counts as one, but that year traditional-industry white-horse leaders delivered very considerable excess returns for institutions). Excessively high expectations at the start of the year and frequent surprises this year (the US-Iran war, China-Europe trade frictions, high interest rates, year-on-year fiscal deficit contraction, etc.) led to market performance that in hindsight was less than satisfactory. But looking ahead to 2027, at a point of generally cautious expectations, the bank believes market breadth will instead widen next year. The valuation contraction process for most sectors has basically been completed this year. AI investment may slow, but its crowding-out effect on other non-AI industries will decline, K-shaped convergence will occur, and the market will become more balanced. Improvement in the capital ecology takes time; stable-return strategies represented by PB-ROE may clearly prevail over prosperity strategies, and should be actively responded to. In terms of industries, it is recommended to allocate around four threads: stable returns, excellent manufacturing going overseas, domestic demand repair, and new AI technology themes. Risk factors: Intensified frictions in China-US technology, trade, and financial fields; domestic policy intensity, implementation effects, or economic recovery falling short of expectations; overseas and domestic 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.