【Shenwan Hongyuan Strategy | Weekly Review and Outlook】The Most Stressful Phase May Already Be Here

(Source: Shenwan Hongyuan Strategy)

1. The deadlock in US-Iran conflict continues, and risk appetite remains under pressure. Attention should be paid to the short-term decline in funds supporting the “Phase One rally” (industry ETF sizes shrinking, pension funds reducing positions to avoid net asset losses, “Fixed Income+” reducing holdings and redemptions). This suggests that we may already be in the most stressful phase. The policy focus on stability and long-term development is reasonable, but note that the structure supporting stability and the absolute return reduction structure may differ, posing tail risks.

We still warn that medium-term uncertainties are underestimated: 1. For China and the US, monetary tightening to counter imported inflation is counterproductive. Increasing inflation tolerance is highly probable. 2. The US economy shows resilience, China has room to maneuver, and recession is not the baseline assumption. 3. Geopolitical deadlock may threaten China’s energy security and supply chain security, potentially creating global alpha. Even if the US-Iran conflict persists with fluctuations, the impact on A-shares is likely to gradually weaken.

The US-Iran deadlock is ongoing, and preparations for a new Middle East order are insufficient. However, forming a new balance will require long-term negotiations. This is reflected in repeated short-term event shocks, directly pressuring capital market risk appetite. Based on the experience of two oil crises, the impact of the US-Iran conflict on the market can be summarized as: rising oil prices, increased freight costs → inflation heats up → monetary tightening → economic recession, confirming stagflation cycle → stock market fundamentals and valuations resonate downward. This logical chain cannot be invalidated in the short term. Meanwhile, we observe that funds supporting the “Phase One rally” are experiencing a short-term decline: 1. Industry ETF sizes are shrinking, especially in non-ferrous metals, chemicals, computers, and media sectors.

2. Absolute return funds, with quick realized gains, are reducing positions to avoid principal losses. Pension funds that previously increased equity holdings are now less stable in the short term. Based on the holdings structure of active public funds and “Fixed Income+” products, sectors like non-ferrous metals, chemicals, communications, and electronics may face de-risking pressures. Equity allocation in this round of increased positions is mainly through “Fixed Income+” products, which are now experiencing redemption pressures. The concentrated fund outflow and policy focus on stability are consistent. Pay attention to potential differences between the structure supporting “stability and long-term development” and the absolute return reduction structure (CSI 300 weight minus industry ETF weight, CSI 300 weight minus “Fixed Income+” holdings). Overall index risk is manageable, but structural shocks may still carry tail risks.

Regarding medium-term projections, we firmly oppose the view that “short-term sharp decline, medium-term slow decline, and the end of large-wave rallies.” We believe the impact of US-Iran conflict is likely to be most significant in the near term. The market’s short-term pricing uncertainty and the reinforcement of adjustments through absolute return reductions suggest a correction phase. However, there are at least three major uncertainties in the medium term, and the outlook is likely to be significantly more moderate than the short-term scenario: 1. Confronted with imported inflation, the optimal monetary policy choices for China and the US may not be tightening. China’s low inflation base and the small probability of oil price-driven policy changes support this. Coupled with mature policy frameworks for structural economic regulation, China is highly unlikely to tighten. In the US, weak employment in the household sector and limited inflationary momentum mean imported inflation pressures are more controllable, especially since the US has become a major oil exporter, reducing imported inflation risks. Powell needs to balance supporting employment, manufacturing return (requiring a weak dollar, low interest rates, and low costs), and managing imported inflation. The view that Powell is hawkish is relative; short-term tightening is not yet confirmed, but medium-term expectations may differ significantly. 2. If a trend of aggressive monetary tightening does not emerge, economic pressures in China and the US remain manageable. 3. Over the medium term, shifts in relative national power become evident, and China’s alpha realization probability increases substantially. Past major global shocks have often led to reassessment of China’s supply chain capabilities. This cycle may see China’s efforts to safeguard supply chain, energy, and security capabilities validated anew, providing a narrative boost for the stock market. Also, this could be an opportunity for capital flows from the Middle East into Chinese assets. Short-term concerns do not necessarily reflect the medium-term outlook; the short term may be the worst, so it’s important to guard against liquidity shocks, maintain confidence, and stay patient.

2. The A-share market is in a consolidation phase between two rising stages. In the short term, the market may follow a pattern of “oversold → policy support for stability and long-term development → rebound.” The subsequent movement is likely to be range-bound, with sector leadership rotating continuously. During this phase, new themes (such as short-term energy storage and optical communications driven by cyclical recovery) may challenge the upper limit of the range; if the rebound stalls, the market could test the lower boundary of the range.

3. In the short term, the focus remains on “practicality,” with CPO and energy storage as strong sectors. Under energy cost shocks, new energy and new energy vehicles benefit from diversification and supply chain resilience, potentially becoming key strategic resources alongside traditional energy. Additionally, the “second phase of rally” (AI industry chain + cyclical price increase cycle) is likely to see pullbacks but offers opportunities for layout, though with limited short-term timing. Historical experience shows that two-stage rallies tend to share similar style characteristics. During the consolidation phase, style shifts are less about switching from high to low and more about sector diversification. High-elasticity investment opportunities mainly come from extending core assets and expanding macro narratives.

Currently, the structural focus remains on “practicality,” with short-term confirmation of the prosperity of CPO and energy storage. Under energy cost shocks, new energy and new energy vehicles benefit from diversification and resilience, potentially becoming important strategic resources and a source of profit diffusion. The market has already identified the strongest sectors; how to judge their sustainability? We believe the pattern of “industry catalysis → valuation rally → valuation at historical highs, then encountering resistance” still applies. When the rally stalls, sideways consolidation is expected, allowing for a calm response. Besides continuously seeking new growth segments, the second major structural theme likely to persist in the medium term is the AI industry chain and cyclical alpha, which should be opportunistically deployed on dips. However, these directions have limited short-term timing.

The medium-term style outlook remains unchanged. Historically, the first stage of rally (structural market) and the second stage (broad market) share similar style traits. The interim accumulation period is not characterized by high-to-low switching but by sector expansion.

We reviewed historical cases from 2014 and 2018-19. We observe that during the early phase of accumulation, strong sectors tend to adjust and stabilize before the second-stage rally begins. The sector performance during the accumulation phase shows weak positive correlation with both the first and second rally stages (no clear style switch). Therefore, the accumulation phase is not a high-to-low switch but rather sector dissipation. Leading sectors and core stocks enter high-level oscillation zones. The space for new opportunities diminishes, and the scale shrinks, which is why it’s a consolidation phase. Nonetheless, high-elasticity investment opportunities mainly come from extending core assets and expanding macro narratives.

Mapping this to the current situation, the “practicality” feature is likely to persist until the first quarter earnings season. The future development of AI industry trends may shift from hardware to applications, focusing on cloud computing, edge devices, and robotics, with domestic AI firms gaining an edge. Opportunities for AI to transform traditional industries (opposite to HALO trades) are also worth noting. Macro narrative expansion includes the potential for increased valuation re-rating driven by relative power shifts among countries, which could be an opportunity for manufacturing sector revaluation.

Risk warning: Overseas economic recession exceeding expectations, and domestic economic recovery falling short of expectations.