AI Trades Are Crowded But Fundamentally Supported; Preference for ChiNext and Power Equipment

Overview

In this strategy report, UBS addresses five key investor questions about current market dynamics. Overall sentiment remains optimistic, primarily driven by robust earnings from tech hardware companies. Although AI-themed trades show elevated crowding, fundamentals remain strong. The report recommends overweighting China’s ChiNext board, tech hardware, and power equipment sectors, while remaining cautious on the Hang Seng Tech Index in the near term. Real estate has been upgraded from underweight to neutral, while consumer sectors remain underweighted.

Core views

AI Trade Crowding and Risks: AI-themed trading is indeed highly crowded, with holdings in popular AI stocks significantly increasing over the past 12 months. TMT sector turnover accounts for approximately 37% of total A-share turnover (historical peak was 43%). However, this level of crowding has persisted for some time without significant recent changes. More importantly, earnings growth for AI hardware companies is accelerating, providing strong fundamental support for valuations. The report highlights that the biggest downside risk stems from global spillovers—specifically, rising correlation between Chinese and U.S. AI tech stocks, which could transmit volatility from a U.S. market correction to China. Potential reversal signals include persistently rising U.S. yields (despite limited historical correlation), slowing earnings momentum (not yet observed), and potential U.S. large-language-model (LLM) provider IPOs, which might be interpreted as a signal of monetization peaking. For investors concerned about crowding, the report suggests focusing on China’s power equipment and energy storage sectors—these not only trade at lower valuations than international peers but also benefit indirectly from global AI data center expansion and serve as a hedge against rising energy prices. Hang Seng Tech (HSTECH) and IPO Lock-up Expirations: Previously anticipated catalysts (e.g., new large model launches, easing food delivery competition, relaxation of chip export controls) have largely materialized, yet market reactions have been muted. The report believes HSTECH will need more time to outperform the broader market, as capital currently favors hardware tech and power equipment. Additionally, July will see a peak in IPO lock-up expirations totaling ~HK$200 billion, involving major AI model firms like Zhipu and MiniMax, as well as JD Industrial. Historical data shows that affected stocks typically underperform the market in the three months prior to expiry. While the overall market impact is manageable (only 0.4% of HK market cap), these events could exert short-term pressure on related stocks and the index. Impact of Rising PPI on Corporate Earnings: Addressing investor concerns about imported inflation (energy-driven PPI increases squeezing margins), the report analyzes historical data and concludes that higher PPI generally coincides with faster revenue and earnings growth for listed companies. Upstream energy and capital goods sectors benefit directly; export-oriented sectors perform well due to pricing power; midstream manufacturers (e.g., chemicals, autos, tech hardware) can partially pass through costs; while downstream sectors with weak pricing power (e.g., food & beverage, utilities) suffer—but these sectors carry low weight (~10%) in the index. Thus, rising PPI may not necessarily harm aggregate corporate earnings. Allocation Recommendations: The report explicitly favors the ChiNext board due to its strong Q1 earnings growth (+23%) and high exposure to tech hardware and power equipment. Sector-wise, real estate has been upgraded to neutral (based on improving secondary home transaction volumes), while consumer sectors remain underweighted, citing soft labor markets and slowing wage growth as headwinds to consumption.

Analysis framework

The report employs a multi-dimensional analytical framework to address investor concerns: 1. **Crowding Quantification**: Monitors mutual fund holdings, overweight ratios in electronics/telecom sectors, and TMT turnover share to quantify AI trade crowding, benchmarked against historical peaks. 2. **Historical Correlation Analysis**: Examines the relationship between PPI YoY changes and non-financial A-share earnings growth since 2012 (correlation coefficient: 0.79), and breaks down historical performance across upstream, midstream, and downstream sectors under inflationary environments to infer current implications. 3. **Event-Driven and Liquidity Analysis**: For Hang Seng Tech, assesses upcoming IPO lock-up expiration volumes relative to total market cap and average daily turnover, supplemented by historical stock performance around past expirations, to gauge market impact. 4. **Cross-Market Linkage Observation**: Notes significantly increased correlation between Chinese and U.S. AI tech stocks, identifying global market volatility as a key external risk for China’s AI trades.

Methodology notes

• Quantitative/Factor/Portfolio Theory

  Trade Crowding Metrics

  The report uses metrics such as fund holding ratios, overweight ratios, and sector turnover share to measure crowding in specific themes (e.g., AI). High crowding typically indicates strong consensus; any negative catalyst or expectation reversal could trigger sharp unwinding.

• Industry/Value Chain Analysis FrameworkUpstream-Midstream-Downstream Transmission

  PPI Transmission Mechanism

  When analyzing inflation impacts, the report assesses a company’s position in the value chain to determine its pricing power and cost-pass-through ability. Upstream commodity producers benefit directly from price hikes; midstream manufacturers partially pass through costs; downstream consumer sectors with weak pricing power suffer. This is a classic framework for linking macro price movements to micro-level profitability.

• Event Arbitrage and Behavioral FinanceEvent-driven analysis

  IPO Lock-up Expiration Effect

  The report examines historical stock price behavior around IPO lock-up expirations (typically underperformance before, rebound after) and calculates expiration size relative to market liquidity to assess whether the event poses idiosyncratic or systemic risk.

Asset mapping & comparison

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

• ChiNext (A-Share Growth Board)

  Preferred market segment

  Strengths

  Strong earnings growth (Q1 +23%), high exposure to tech hardware and power equipment

  Comparison

  Outperforms Hang Seng Tech Index

• Power Equipment & Energy Storage Sector

  Indirect beneficiary of AI compute infrastructure build-out and inflation hedge

  Strengths

  Valuations below international peers; fundamentals supported by global AI data center (AIDC) construction and energy demand

  Comparison

  Alternative to crowded direct AI plays

• Hang Seng Tech Index (HSTECH)

  Cautious in the short term

  Strengths

  Some catalysts already realized (e.g., new model launches)

  Weaknesses

  Capital flowing to hardware and Northeast Asian markets; faces July lock-up pressure; constituents include internet/consumer firms impacted by regulation or competition

  Comparison

  Underperformed global markets by ~20 percentage points YTD

  Risks

  Short-term selling pressure from IPO expirations; earnings downgrade risk

• Real Estate Sector

  Upgraded to neutral

  Strengths

  Improving secondary home transaction volumes; declining listing inventory

  Weaknesses

  Lingering doubts about sustainability of recovery

  Comparison

  Upgraded from previous underweight

Key data

• TMT Sector Turnover Share~37%Of total A-share turnover; elevated but below the 2023 historical peak of 43%
• ChiNext Q1 Earnings Growth+23%2026 Q1 data, indicating strong earnings momentum
• Projected July Lock-up Expiration Volume~HK$200 billionApproximately 0.4% of total HK market cap, equivalent to 3/4 of average daily turnover
• PPI-Earnings Correlation0.79Correlation coefficient between PPI YoY and non-financial A-share earnings growth since 2012
• Hang Seng Tech YTD Performance-10%Significantly underperformed MSCI AC World Index (which is near all-time highs)

Impact & implications

For investors, this implies that chasing AI software or internet platforms alone may expose portfolios to valuation pressure and capital rotation risks. Instead, shifting toward AI hardware infrastructure with solid earnings growth (e.g., optical modules, servers) and power equipment sectors that support AI data centers offers better risk-adjusted returns and margin of safety. Additionally, short-term volatility from July HK-listed AI model company lock-up expirations warrants caution. On the macro front, sustained PPI recovery could favor export-oriented and upstream resource sectors over pure domestic consumption plays.

Risks

• Global spillover risk: Heightened correlation between Chinese and U.S. AI tech stocks means U.S. market corrections could drag down China’s AI sector
• Rising U.S. yields: If energy-driven U.S. Treasury yields continue climbing, they could compress tech valuations
• Earnings deceleration: If AI hardware earnings growth disappoints, highly crowded trades could reverse rapidly
• Weak labor market: High youth unemployment and slowing wage growth may constrain broader consumption recovery

What to watch

• July HK IPO lock-up expirations, especially share price performance of AI model firms like Zhipu and MiniMax
• U.S. 10-year Treasury yield trajectory and its spillover effect on Chinese hardware tech stocks
• IPO progress and market reception of major U.S. LLM providers
• Future PPI trends in China and sector-specific ability to pass through rising input costs