The Chinese stock market is currently experiencing a period of adjustment, characterized by several prominent trends. Firstly, trading volumes are continuing to decline, reflecting a pervasive sense of pessimism among various types of investors. Secondly, most economic sectors that are closely tied to economic performance are witnessing a downturn, signaling growing concerns over intensifying downward pressures on the economy. Lastly, a noticeable divergence in performance between large-cap and small-cap stocks persists; for instance, the A50 index saw only a slight decline of 0.4% in June, whereas the Zhongzheng 1000 and Zhongzheng 2000 indices plummeted by over 8%. This disparity illustrates a profound recalibration among investors, indicating increased caution towards smaller companies that may be more vulnerable during economic uncertainties.

Amidst this challenging landscape, the downward pressure on the Chinese economy remains palpable. Data from macro and meso economic indicators in May and June collectively point towards economic strain. The price of Moutai liquor, which is considered a key indicator of business activity in China, has been steadily declining since the second quarter, reflecting a continuous contraction in commercial activity. Overall, it seems that a consensus has formed around the notion that the economy is persistently weakening. This sentiment is echoed by the recent drop in the 30-year government bond yield, which has fallen below 2.5%, and the 10-year government bond yield, which dropped below 2.3%. For comparison, the average yield on 30-year government bonds in the Eurozone stands at around 2.6%, while Japan's is approximately 2.2%. The implications of these yields, reflective of economic growth and inflation expectations over the coming three decades, raises the question: does our current pricing—positioned between Japan and the Eurozone—indicate optimism, a grim outlook, or room for further decline?

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Our understanding of interest rate levels is not rooted deeply in technical analysis, but derived from common sense and relevant considerations. From a micro-economic perspective, however, there are notable bright spots. For instance, sales of products linked to infrastructure development remain robust, such as engineering machinery used for irrigation in agriculture. Additionally, there has been a marked improvement in the sales of second-hand properties in major cities like Beijing, Shanghai, Guangzhou, and Shenzhen since the new policies were implemented in May, with this momentum stretching beyond the levels observed in August and September of the previous year. Furthermore, the RMB's depreciation, which aligns with trends seen in other currencies like the Japanese yen, could present short-term challenges in terms of capital outflow. Yet, from a mid-term perspective, currency devaluation can alleviate economic stress and pressure on asset prices, thus facilitating a future recovery.

Judging short-term economic indicators has proven quite difficult, and their utility for informing long-term investment decisions in stocks is limited. We maintain a mid-term outlook suggesting an “L-shaped weak recovery”. In this phase, as the economy adjusts, it will release historically accumulated risks tied to real estate and local government debt. Meanwhile, we note an increasingly significant share of high-end manufacturing and technology industries in exports. The central government's debt-to-GDP ratio and the high savings rate among households indicate substantial potential for economic stimulus. Current policy options focus on strengthening foundational elements and targeted measures, with broader stimulus packages anticipated in the future.

In terms of capital markets, leading firms with high-quality attributes are clearly defined and are expected to continue to deepen their market presence. The evolution of China's capital markets is beginning to align more closely with those of more mature markets. Going forward, stocks of industry-leading firms, those who prioritize operational excellence, and companies that emphasize shareholder returns will be at the forefront of investment selection. Our stock selection framework will, on one hand, take into account industry vitality, scrutinizing data changes, policy guidance, and technological evolutions; on the other hand, it will examine the essence of the business—considering competitive landscape, shareholder returns, and valuation appeal.

Exploration on Growth Stocks' Business Models

This discussion centers on the application of AI on the edge.

The entry of Apple has significantly accelerated the adoption of AI applications at the edge, particularly through its mobile and PC platforms. We can anticipate by the second half of the year the rollout of practical AI applications, including AI-assisted features with the introduction of the iPhone 16, which will empower millions of Apple device users. Other manufacturers, including Android and HarmonyOS, are likely to follow suit with similar features in their products by 2024 and 2025.

The use of AI at the edge is expected to trigger a massive explosion of AI applications targeting consumer interfaces. Previously, Microsoft showcased AI integrations within its Office and Windows software, but these advancements have not yet reached the average consumer's daily experience. Smartphones, as the most widely adopted consumer electronics worldwide, are now set to become the central vehicle for integrating AI into mobile internet ecosystems. AI combined with smartphones symbolizes the convergence of artificial intelligence and the mobile internet.

The first wave of AI-driven transformations will primarily manifest through the upgrade of hardware products. Over the past five years, from the iPhone X to the iPhone 15, the upgrade cycle for smartphones has noticeably decreased; this is largely because the pace of technological advancements has slowed. History suggests that, similar to televisions and computers, consumers are extending the lifespan of their smartphones and reducing the frequency of upgrades, which poses challenges for the hardware industry. If the consumer experience undergoes a significant shift due to AI integrations—and we suspect it likely will—then AI smartphones could outshine conventional models, leading to a renewed wave of hardware upgrades.

AI's synergy with the mobile internet is expected to ignite a second technological wave starting in 2025, or potentially later. Once millions of users transition to AI-optimized smartphones, regardless of the operating system—iOS, Android, or HarmonyOS—this shift will mirror the transformative growth seen during the rise of mobile internet. The development of new applications inspired by AI capabilities will pave the way for software and internet firms to innovate significantly. However, while the hardware shift may present clear beneficiaries, the incorporation of AI into applications may adversely impact certain sectors, leading to a more nuanced landscape where some businesses thrive while others falter.

The explosion of AI applications at the edge will yield distinct advantages for certain areas while posing risks to others; however, the overall societal efficiency will see enhancements. Additionally, from the standpoint of the industrial chain's competitive advantage, as AI models reach maturity and edge applications proliferate, China holds a distinct global advantage in its consumer electronics manufacturing and internet application sectors.