Unwinding of Crowded AI Trades Drives Sector Rebalancing, A-Share Valuations Return to Neutral Range

Overview

The report reviews China’s equity market in July 2026 and macro data for June. The most prominent features in July were the significant divergence between onshore A-shares and the Hong Kong offshore market, and a rapid rotation from high-valuation, crowded AI trades into defensive and value sectors. Major A-share indices corrected sharply, with information technology and AI-exposed materials and industrials under pressure; consumer staples, energy, and financials were relatively strong. Meanwhile, the share of margin trading and margin balances declined, and CSI-300 valuations fell, indicating that earlier leverage and valuation pressures have been partially released. The policy backdrop improved marginally, but macro data still showed a structure in which production was stronger than demand, external demand was stronger than domestic demand, and innovation investment was stronger than traditional investment.

Core views

First, the July market correction was mainly driven by style rotation, the unwinding of crowded AI trades, and deleveraging, rather than a simple collapse in earnings expectations. Second, margin purchases as a share of turnover have approached cyclical lows seen during previous bull markets, and valuations have also returned to a relatively neutral range, reducing pressure for further sharp market derating. Third, the policy tone is shifting toward greater emphasis on fiscal execution and countercyclical adjustment, which may support earnings growth expectations for Chinese equities in 2026 to 2027. Fourth, macro recovery remains uneven: industry, high-tech manufacturing, and some exports are strong, while consumption, real estate, traditional manufacturing, infrastructure, and credit expansion remain weak. Fifth, short-term market opportunities are more likely to come from sector rebalancing and valuation repair, while a broad trending market still requires confirmation from improvements in domestic demand and the credit cycle.

Analysis framework

The report combines monthly returns of major equity indices and sectors, margin trading and margin balances, fund positioning, earnings forecast revisions, and next-twelve-month P/E ratios to assess market style, crowding, deleveraging progress, and valuation position; it also evaluates the macro environment and its impact on corporate earnings through indicators such as industrial production, retail sales, fixed asset investment, real estate, trade, inflation, credit, social financing, exchange rates, and government bond yields.

Methodology notes

• Market performance analysisCross-market and large-/small-cap index comparison

  Identify divergences between onshore and offshore markets and market-cap styles through differences in monthly returns among the CSI-300, CSI-500, CSI-1000, HSI, and HSCEI.

  In July, major onshore indices fell significantly while Hong Kong indices rose, reflecting stronger pressure from the unwinding of crowded A-share trades and deleveraging, while offshore internet stocks benefited from short covering and policy optimism.

• Style and sector analysisSector rotation and crowding analysis

  Compare sector returns and combine AI exposure, valuations, and changes in margin trading to assess the migration of capital from growth themes toward defensive and value sectors.

  Consumer staples, energy, and financials led gains, while information technology and AI-exposed materials and industrials declined, showing a rapid reversal of trades previously concentrated in the AI theme.

• Valuation analysisHistorical standard deviation positioning of next-twelve-month P/E

  Compare the CSI-300’s next-twelve-month P/E with the historical median and standard deviation since 2016.

  The P/E ratio of 13.2x is about 0.6 standard deviations above the historical median, indicating valuations remain slightly above the long-term center but are clearly below the expansion level previously driven by the AI rally.

• Macro fundamentals analysisIntegrated tracking of production, demand, credit, and prices

  Jointly examine industrial production, consumption, investment, trade, inflation, loans, and social financing to assess the strength and breadth of economic growth.

  Industry and high-tech manufacturing stabilized, but fixed asset investment, real estate, private investment, and credit remained weak, indicating that the economy still relies on external demand and advanced manufacturing support, while endogenous demand has not yet formed a broad recovery.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• CSI-300

  Benchmark for China large-cap blue-chip stocks

  Strengths

  Valuations have fallen back to a relatively neutral range, and consensus EPS for 2026 still maintains relatively high growth.

  Weaknesses

  Weak domestic demand and credit may constrain earnings delivery, and policy support has not yet reached the level of large-scale stimulus.

  Comparison

  The July decline was smaller than those of the CSI-500 and CSI-1000, but it significantly lagged the HSI and HSCEI.

  Risks

  Downward revisions to earnings expectations, policy execution falling short of expectations, and deterioration in external risk appetite.

• CSI-500 and CSI-1000

  Benchmarks for China small- and mid-cap stocks

  Strengths

  If liquidity and risk appetite recover, they have higher rebound elasticity.

  Weaknesses

  More sensitive to the unwinding of crowded trades, deleveraging, and contraction in growth valuations.

  Comparison

  They fell 17.0% and 19.7% respectively in July, significantly underperforming the CSI-300.

  Risks

  Continued margin contraction, cooling of thematic trades, and insufficient earnings support.

• HSI and HSCEI

  Benchmarks for Hong Kong offshore Chinese equities

  Strengths

  Supported by short covering, a rebound in internet stocks, and policy optimism.

  Weaknesses

  If the rally is mainly driven by position covering, sustainability still requires validation from earnings and fund flows.

  Comparison

  They rose 13.1% and 13.9% respectively in July, significantly outperforming major A-share indices.

  Risks

  Cooling policy expectations, changes in overseas liquidity, and internet sector earnings falling short of expectations.

• Consumer staples, energy, and financials

  Beneficiary directions of defensive and value styles

  Strengths

  They have relative resilience during market volatility and growth-stock derating phases, and receive support from capital rotation.

  Weaknesses

  If economic demand remains weak, consumer and financial fundamentals may still come under pressure.

  Comparison

  Their July performance was significantly better than information technology, materials, and industrials.

  Risks

  Transfer of trade crowding, declines in commodity prices, deterioration in asset quality, and consumption recovery falling short of expectations.

• Information technology and AI-related sectors

  Previously high-valuation growth and thematic trade directions

  Strengths

  High-tech manufacturing and AI-related production maintain rapid growth, and the long-term industry trend remains supportive.

  Weaknesses

  Positions are crowded and valuations are high, making them highly sensitive in the short term to changes in risk appetite and financing conditions.

  Comparison

  Information technology fell 30.7% in July, making it the weakest-performing sector; AI-exposed materials and industrials also lagged significantly.

  Risks

  Further valuation compression, insufficient earnings delivery, slowing capital expenditure, and further unwinding of crowded trades.

• Chinese government bonds and the renminbi

  Macro assets reflecting domestic growth, policy, and financial conditions

  Strengths

  Weak economy and credit provide some support for bonds, with the 10-year government bond yield remaining low.

  Weaknesses

  Stronger countercyclical policies may push up interest rates and alter exchange rate expectations.

  Comparison

  As of end-July, the 10-year China government bond yield was around 1.7%, and USD/CNY was around 6.75.

  Risks

  Changes in the intensity of fiscal stimulus, capital flows, external interest rates, and fluctuations in the trade environment.

Key data

• July returns of major A-share indicesCSI-300 -7.9%; CSI-500 -17.0%; CSI-1000 -19.7%Small- and mid-cap indices fell more, showing more pronounced pressure on high-beta and crowded trade directions.
• July returns of major Hong Kong indicesHSI +13.1%; HSCEI +13.9%The offshore market was supported by short covering and policy optimism.
• Margin trading indicatorsMargin purchases accounted for 8.2% of A-share turnover; margin balance declined by about RMB300 billion from its recent highThe report believes the most difficult stage of deleveraging may have passed.
• Leading sectors in JulyConsumer staples +11.5%; energy +11.1%; financials +8.3%Capital rotated toward defensive and value styles.
• Lagging sectors in JulyInformation technology -30.7%; materials -13.8%; industrials -10.6%Mainly affected by the unwinding of crowded AI trades and concerns over high valuations.
• CSI-300 earnings expectationsConsensus EPS growth of 19% in 2026Data as of end-July 2026.
• CSI-300 valuationNext-twelve-month P/E of 13.2xAs of July 31, about 0.6 standard deviations above the median since 2016.
• June industrial productionUp 5.3% year-on-yearHigher than 4.5% in May, with high-tech manufacturing and AI-related production performing strongly.
• June retail sales of consumer goodsRMB4.27 trillion, up 1.0% year-on-yearRecovered from a 0.6% year-on-year decline in May, but automobile and housing-related consumption remained weak.
• Fixed asset investmentDown 10.0% year-on-year in June; down 5.7% year-on-year cumulatively in the first halfReal estate investment fell 18.0% cumulatively, and private investment fell 8.5% cumulatively.
• New loans in JuneRMB1.61 trillionThe weakest June performance since 2021, with both corporate and household loans weak.
• Financial conditionsSocial financing growth of 7.4%; USD/CNY at 6.75; 10-year China government bond yield around 1.7%Credit expansion was weak, and long-end interest rates remained low.

Impact & implications

At the market level, valuation declines and margin deleveraging have reduced the risk of a continued rapid valuation compression in A-shares, and defensive, value, and relatively stable cash-flow sectors may continue to attract capital. Marginal policy improvement helps stabilize earnings expectations, but before fiscal measures are implemented and transmitted to consumption, investment, and credit, index performance may remain volatile and sector performance highly divergent. For growth sectors, the AI industry trend has not been negated, but crowded positioning and high valuations need to be digested in the short term; for macro-sensitive assets, real estate, private investment, and loan data remain key to judging whether the economy can shift from production stabilization to demand recovery.

Risks

• Domestic consumption, real estate, traditional manufacturing, and infrastructure investment remain persistently weak, and the scope of economic stabilization may be too narrow.
• New loans and social financing growth are weak, and the credit cycle has failed to effectively support corporate earnings and household demand.
• The Politburo meeting sent positive signals, but if fiscal execution is slow or countercyclical support is weaker than expected, the market may revise earnings forecasts downward again.
• Crowded positions in AI and other growth themes may continue to unwind, and high-valuation sectors still face further correction.
• Export growth is concentrated in high-tech, automobiles, and some consumer goods, and changes in external demand may weaken support from the production side.
• Rapid market rotation may increase volatility, and defensive and value sectors may also experience pullbacks after trades become overly concentrated.
• Inflation transmission remains insufficient, and weak domestic demand may limit corporate pricing power and margin improvement.

What to watch

• Whether the pace of fiscal spending and new countercyclical policies can translate from policy statements into actual demand.
• Whether margin purchases as a share of turnover, margin balances, and turnover structure confirm the end of deleveraging.
• The direction of CSI-300 earnings forecast revisions and whether the 13.2x valuation can be supported by earnings delivery.
• Whether retail sales, real estate sales and investment, private investment, and household loans can continue to improve.
• Whether strength in high-tech manufacturing and AI-related production can spread to traditional manufacturing and services.
• Whether the rise in the HSI and HSCEI is sustained by continued fund inflows and earnings improvement, rather than driven only by short covering.
• Changes in valuations, position crowding, and earnings expectations for the information technology sector after the sharp correction.
• Changes in financial conditions reflected by the RMB exchange rate, the 10-year China government bond yield, and social financing growth.