Chen Guo: External turbulence persists, A-shares focus on three asset classes

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External headwinds are still ongoing. The A-shares market is focused on three categories of assets【Oriental Fortune Strategy Chen Guo team】

Source: Chen Guo Investment Strategy

Abstract

This week, elevated oil prices caused by the U.S.-Iran conflict remain the core external variable affecting global capital markets. As the conflict escalates, expectations for stagflation and recession are heating up.

From an asset pricing perspective, global broad asset classes—including global equity markets, the U.S. dollar, U.S. Treasuries, precious metals, industrial metals, and others—have already responded to stagflation and recession risks to a certain extent. Since late March, the reconciliation signals continuously released by Trump, together with the combined pressure from the U.S.’s internal economic, financial, and political fronts, may gradually increase hedging constraints on the escalation and continuation of the conflict.

In the short term, it is also important to recognize that the conflict may not quickly downgrade—or even come to a halt. There still remains some risk of escalation or repetition. This may continue to pose a certain degree of volatility risk to global markets.

China’s assets overall are expected to demonstrate resilience, and even find opportunities amid adversity. Given that the impact of the U.S.-Iran war on China’s economy is relatively indirect and limited, in the medium term, the Chinese stock market’s reaction to the war is likely to gradually dull. As we pointed out in our weekly report earlier, not considering short-term oil price fluctuations, after this oil supply crisis, the global energy transition may also accelerate, and China’s new energy system is expected to become one of the winners. In addition, you can also look at industries with low correlation to oil prices—for example, pharmaceuticals. China’s innovative drugs’ share in global markets may also continue to maintain an upward trend. Finally, even if there are downside risks to external demand in the medium and short term, China-made products’ relative cost and competitiveness advantages may allow its overseas market share to continue rising, and overall it is expected to show relatively strong resilience.

The structural allocation centers on three categories of assets: first, under the overseas energy crisis, potentially benefiting assets. In particular, China’s new energy, including wind power, solar PV, energy storage, lithium batteries, new energy vehicles, and so on—focus on energy- replacement and manufacturing-advantage sectors such as coal, natural gas, coal-chemical industry, and machinery. Second, resilient assets, mainly industries with weak correlation to oil prices, such as pharmaceuticals, banks, real estate, and public utilities. Third, currently high-visibility/high-growth assets—using resilience on the earnings side to counter valuation-side pressure, including semiconductor equipment, optical modules, PCBs, optical fibers, and others. But within this direction, some varieties also need to be mindful of the risk that external demand could be sharply downgraded later.

Key industries to focus on: new energy industry chain, innovative drugs, banks, real estate, coal, natural gas, semiconductor equipment, and others.

Risk warning: overseas risk disruptions intensify; the continuity of AI industry chain capital expenditure is less than expected; domestic policy and economic recovery are less than expected, and so on.

1

Geopolitical disruptions gradually cool off, leaving limited downside room for the market

Recently, the U.S.-Iran conflict has continued to intensify, becoming the core external variable disrupting global capital markets. Escalation of the conflict directly pushes up the prices of commodity products such as international crude oil and natural gas, further strengthening the global stagflation trading logic. Risk appetite in global equity markets has broadly weakened at the same time; both the U.S. stock market and A-shares have shown phase adjustments.

Judging from recent developments in overseas situations, the most pessimistic stage for geopolitical risk may be gradually passing. Since late March, Trump has repeatedly released signals about dialogue with Iran through social platforms and public interviews. He has successively stated his willingness to talk with Iran’s new leadership and urged Iran to advance negotiations on a peace agreement as soon as possible, while geopolitical diplomatic mediation continues to advance. Price performance of broad asset classes also confirms this. Even though on Friday international oil prices still remained at a high level with a volatile trading pattern, the price of copper within industrial metals has shown a slight recovery. The prices of gold and silver have also stopped falling and stabilized in parallel. Some assets that were hit more by geopolitical disruptions earlier have already, in terms of price, shown margin improvement signals.

At the same time, internal economic and political pressures in the United States further constrain the conflict from continuing to escalate. The U.S. may have stronger motivation to ease the geopolitical situation. Currently, internal stress in the U.S. economy is prominent. U.S. Treasury yields remain at high levels, and the repair process of traditional manufacturing under a high-interest-rate environment continues to slow. Combined with sticky inflation still present, pressure from stagflation in the economy is gradually becoming evident. The U.S. stock market has weakened significantly under stagflation and recession expectation scenarios. In addition, in a high interest-rate environment, risks have frequently occurred in the private credit sector, further increasing uncertainty in U.S. financial markets. On top of this, with the upcoming U.S. midterm elections in April, the Trump administration is urgently seeking to stabilize the economic and financial market situation. The Strait of Hormuz is virtually blockaded in practice and oil prices are surging at high levels—this brings harm to the U.S. economy, finance, and politics with little benefit. The U.S.’s willingness to ease the situation and advance diplomatic reconciliation is expected to be strong. Against this backdrop, even if global stagflation and recession expectations have not been fully eliminated, market pessimistic expectations have entered a path of marginal cooling.

However, despite the reconciliation signals from Trump suggesting moves to cool the conflict, in terms of market pricing, the current trading participants generally still believe that the conflict is unlikely to end in the short term, and that war may continue into the second quarter.

Looking ahead, considering the actual impact of this round of conflict, U.S. forces and related allied military strikes have mainly focused on military targets, and have not destroyed Iran’s core oil production, export, and energy infrastructure. The global crude oil supply side has not suffered sustained and destructive strikes. Combined with the fact that the global crude oil market was originally in a supply-and-demand relatively loose pattern, with only short-term oil prices being pushed up due to geopolitical sentiment shocks, the overall assessment is that as long as the geopolitical conflict does not further expand and core energy infrastructure is not affected, with diplomatic mediation advancing and the geopolitical situation gradually easing, oil prices are likely to revert to supply-demand fundamentals and be hard to sustain at continuously high levels. As geopolitical risks gradually recede and stagflation expectations marginally ease, external disruption factors to A-shares are expected to keep weakening, leaving relatively limited overall downside room.

2

Pessimistic expectations are being repaired; prioritize low-volatility, interference-resistant tracks

The market’s core trading theme is still the severe volatility in oil prices caused by the escalation of the U.S.-Iran conflict, behind which lurk global stagflation—and even recession—expectations that continue to suppress overall market risk appetite. At present, the market’s trading expectations logic regarding the subsequent oil price trend and the transmission impact of high oil prices is becoming clearer step by step: if geopolitical conflict continues to escalate and shipping through the Strait of Hormuz is obstructed, pushing oil prices to keep rising, it would significantly intensify global imported inflation pressures. Meanwhile, current U.S. interest rates remain high; the repair progress in traditional manufacturing sectors is relatively slow, and endogenous growth momentum in the economy is relatively weak. Combined with inflation persistence brought by high oil prices, it may further compress the Federal Reserve’s room for monetary policy easing, thereby strengthening market expectations for global stagflation and even a move into recession. Under this transmission pathway, market outlooks for end demand for industrial metals have become cautious, which in turn puts phase pressure on industrial metal prices. At the same time, expectations for Fed rate hikes have warmed up, directly suppressing gold price performance, strengthening the U.S. dollar index, lifting U.S. Treasury yields, and causing the risk appetite of global equity markets to fall further overall.

We believe that even under a pessimistic scenario assumption, if the oil price pricing center continues to rise, A-share industries will not present a synchronized damage pattern. The differences in each industry’s oil-price sensitivity will lead to a more noticeable divergence in sector performance.

From the industry benefit logic, during the oil price upcycle, the sector differentiation pattern is especially clear. In an oil price upcycle, sectors with resource attributes and direct benefits from higher crude oil prices tend to benefit first. Among them, we believe that oil and gas exploration and production, as part of the oil-and-gas upstream segment, directly benefits from both volume and price rising brought by oil price increases. The oilfield services engineering industry will see synchronous growth in orders and revenues as upstream capital expenditures expand, and industry conditions will continue to move upward. The oil shipping sector benefits as the crude oil trade pattern is restructured under high oil prices and shipping demand rises, lifting the freight cost center of gravity systemically. The coal industry, relying on the energy- substitution logic, stands out economically in a high oil price environment; demand may shift toward coal, making it a configuration direction that combines defensive and resilient characteristics during the oil price upcycle.

Beyond the directly benefiting sectors, oil price increases will also drive indirect benefits for some industries through channels such as energy substitution and cost pass-through. New energy and renewable energy sectors, under the background of high oil prices strengthening energy security and the strategic significance of the energy transition, see policy support and capital expenditure intentions rise in tandem, and infrastructure investment demand continues to be released. The new energy vehicle industry, because the oil price increase amplifies the cost comparison advantage of vehicle use, is expected to accelerate the “oil-to-electricity” process, and industry penetration rates may further improve. The gas (LNG) sector benefits from the price linkage effect brought by oil price increases; the profitability of gas-source enterprises is expected to improve in sync as LNG prices rise. In the coal-chemical industry, when oil prices are high, the economics compared to petroleum-chemical routes become significantly stronger, and the substitution effect remains prominent. The agrochemicals industry is supported by a cost-driven price increase logic; as crude oil prices rise and lift fertilizer and pesticide production costs and transmit them to the end market, companies holding product inventory will fully benefit from improved earnings brought by rising prices.

By contrast, rising oil prices will create a clear impact on industries with weak cost pass-through ability and high energy dependence, and there is some risk of squeezing profit margins. In the aviation industry, the cost of jet fuel accounts for a relatively high share of operating costs, and constraints from market competition make it difficult to quickly pass costs to end consumers, so profit is directly hit by oil price increases. In the pure downstream petroleum refining and chemical industry, crude oil is the core cost; product prices are simultaneously constrained by both market competition and policy pressures, resulting in weak ability to pass through price increases, and profitability faces some pressure as oil prices rise. In the chemical industry’s mid-to-downstream segments, as well as in chemical fibers and rubber/plastics, the core costs are petroleum-based feedstocks. Oil price increases drive feedstock costs sharply higher, but downstream demand elasticity limits the room to raise prices, so cost increases may be significantly higher than price increases, making profit recovery harder.

In addition, some industries have relatively low linkage between cost structure, business models, and oil prices, so the impact of oil price volatility is limited. Software and internet industries’ core costs are labor, and they almost do not depend on petroleum-based feedstocks or fuel consumption. The financial industry’s business model has no direct connection to oil prices, and in a period of market volatility it has some defensive characteristics. In some medical device industries, core costs are R&D and precision manufacturing, making them less sensitive to oil prices; only packaging costs have a small impact. For industries such as education, media and entertainment, and telecom operators, they may follow light-asset, low-energy-dependence models, or have core business focused on content production and operation of network infrastructure, which are weakly directly linked to crude oil prices, so the earnings impact from oil price fluctuations is relatively limited.

Leaving aside short-term geopolitical conflict and oil price volatility disruptions, looking at A-share industries’ core driving factors, the stability of external demand is still a key variable affecting domestic supply-chain earnings. But the uncertainty it faces is also not to be ignored. In the context of warming global stagflation and recession expectations, overseas overall consumption and production demand face phase weakening pressure, and the external demand chain as a whole cannot stay unaffected. Most are manufacturing and technology sectors that rely on exports to overseas markets, and in the short term, earnings still face certain downside risks. Looking at the medium and long term, high-quality tracks in China with global core competitiveness, a high export share, and strong product pricing power still have strong industry advantages and earnings resilience. However, at this stage, constrained by geopolitical conflict disruptions and relatively weak global economic expectations, it is necessary to use more resilience and certainty on the earnings side to counter valuation-side pressure, focusing on industries with high certainty and strong visibility, such as optical modules, PCBs, memory, optical fibers, and semiconductor equipment.

Based on the two core logics—geopolitical oil-price disruption and the divergence in the external demand schedule—given the current market environment of unclear overseas conditions and weaker market risk appetite, we recommend focusing on three major investment themes:

First, low-volatility, resilient sectors that can be positioned now and have low correlation with oil prices and stable earnings (banks, non-bank financials, pharmaceuticals, real estate). Second, coal, natural gas, oilfield services engineering, and oil shipping sectors that directly benefit during the oil price upcycle, and indirectly benefit from China’s new energy industry (including wind power, energy storage, solar PV, and new energy vehicle industry chains). Third, export-demand-resilient sectors with global competitiveness in sub-segments, using resilience and certainty on the earnings side to counter valuation-side pressure—focus on industries with high certainty and strong visibility, such as optical modules, PCB, memory, optical fibers, semiconductor equipment, and so on.

Risk warning

1）Overseas risk disruptions intensify: global geopolitical conflicts intensify, regional frictions and economic-and-trade games heat up, boosting global risk-avoidance sentiment and triggering cross-border capital flows and volatility in risk assets. Meanwhile, there is uncertainty in the monetary policy paths of overseas major economies. Fluctuating rate expectations will suppress growth-sector valuations again and again, creating phase external disruptions to A-shares. 2）AI industry chain capital expenditure continuity is less than expected: global AI compute power and data center investment are highly dependent on the capital expenditure cycle of overseas tech giants. If corporate earnings are under pressure and the payback cycle of investments lengthens, it may lead to slower AI capital expenditure growth, thereby weakening demand conditions in upstream links such as compute power, hardware, materials, and other segments, and affecting the growth certainty of the AI infrastructure chain. 3）Domestic policy and economic recovery are less than expected: China’s domestic economy is still in a stage of stabilization and recovery repair, with weak endogenous momentum. Real estate sales and private investment recovery are slow. If the economic recovery pace slows further, it will further suppress market earnings expectations and risk appetite.

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Responsible editor: Chang Fuqiang