CICC Strategy: Prosperity is the core criterion for testing the technology market

1. Why have technology growth stocks performed well recently?

Despite increased market volatility recently, technology growth stocks have stood out. From May 24th to June 12th, the Sci-Tech Innovation 50 index rose against the market by 1.69%, leading the major broad-based indices. At the industry level, growth industries represented by electronics, defense, military, and automotive sectors have shown superior performance.

We believe the core reason behind this is the acceleration of industry rotation and the lack of a clear main theme, leading to a "high cut low" market style. By summing up the absolute value of the changes in the ranking of industry turnover rates over the past five days, we have constructed an industry rotation intensity index. Since May, the rotation intensity has rapidly increased, leading the market into a relatively chaotic period with no clear main theme. Coupled with the high crowding in the previous market, trading volume and sentiment have fallen from their highs, prompting investors to seek industries that are at low levels and have sufficient "margin of safety."

On the one hand, the crowding and stock prices of technology growth in the latter half of May were at low levels. In terms of crowding, as of May 24th, the crowding levels of most sub-sectors of growth industries such as semiconductors, consumer electronics, optical modules, computer equipment, military electronics, and office software were at relatively low levels. In terms of stock price positions, as of May 24th, growth styles have performed poorly since the beginning of the year, with computers, electronics, media, and defense sectors leading the declines. In terms of the growth/value ratio, by late May, the relative position of growth/value had also fallen to historical lows.

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On the other hand, looking globally, some technology sectors in A-shares also have relatively high cost performance. For example, the A-share semiconductor and Philadelphia Semiconductor Index are at historically low valuations, attracting northbound funds to continue increasing their holdings in the semiconductor and consumer electronics industries since late May, thereby strengthening the growth stock dominance.

At the same time, industrial and policy catalysts have also added fuel to the technology stocks. On one hand, the National Large Fund Phase III was officially established on May 24th with a registered capital of 344 billion RMB, exceeding the total of the previous two phases, which will continue to support the development of the domestic semiconductor industry. On the other hand, at the WWAC held by Apple on June 10th, Apple Intelligence was introduced, and the AI application end is expected to accelerate its implementation, driving the rise of AI stocks in the U.S. and reflecting on the domestic industry.

In summary, the recent outperformance of technology growth stocks is mainly due to market funds "rotating from high to low" and the catalysis of industrial policies.

II. This round of technology stock rebound still favors leading companies and high prosperity

Recently, technology stocks have performed well, especially the hot concept of "KoteGu". Many investors are concerned whether the market will return to the mode of "themes" and "small caps". However, it is worth noting that this round of technology stock rebound is not a broad rise, with significant internal differentiation, still favoring leading companies and high prosperity.

This round of technology stock rebound still favors leading companies. The CICC strategy team has repeatedly pointed out since the beginning of the year that with the reshaping of the core asset unified front of the funding side and the highlighting of the leading profit advantage, leading companies will become an important source of excess returns this year. We have calculated the median price changes of the top 5 largest companies in the aerospace, electronics, and other growth sectors from May 24th to June 12th, and found that the top 5 largest companies in each sector have shown significant excess returns. Taking the electronics and defense sectors, which have performed the best recently, as examples, the average increase of the top companies in these sectors is 4.9% and 4.8%, while the median price changes of non-leading stocks in the sectors are only -0.1% and -3.8%

Moreover, the economic situation is also an important factor leading to the differentiation of the market. At the industry level, in this round of growth stock rebound, semiconductors, consumer electronics, optical modules, and military industry sectors led the way with improved fundamental expectations, while media and new energy sectors, which are still at low levels of prosperity and with unclear expectations, performed poorly. At the individual stock level, since May 24th, among various growth industries/sectors, the median change in stock prices of companies with upward earnings expectations has significantly outperformed those with downward earnings expectations.

Therefore, in this round of rebound for technology growth stocks, leading companies and high prosperity still represent a high winning investment model, and the market's aesthetic preferences have not changed.

III. In the era of high winning investment, prosperity is the core criterion for testing the technology market

Since the beginning of this year, CICC Strategy has proposed that the market will enter a high winning investment mode, summarizing it as the three main themes of high prosperity, high ROE, and high dividends. When the market has a certain direction of prosperity or industrial trend, high prosperity is the highest winning choice, and offense is the best defense. Typical examples include the high prosperity-driven US stock AI sector and the A-share optical module market. Therefore, in the era of high winning investment, prosperity is the core criterion for testing the technology market.

The core reason for the continued bullish trend in the US stock market lies in the support of technology stocks under the wave of the AI industrial revolution. Since 2023, as of June 12, 2024, the S&P 500 index and the Nasdaq index have risen by 41.2% and 68.2% respectively. Upon closer examination, we find that the main drivers of this rise come from AI-related stocks: heavyweight stocks such as Microsoft, Google, NVIDIA, AMD, Facebook, etc., have all achieved significant gains under the wave of AI. When we exclude AI-related stocks, we can see that the market value-weighted return level of the remaining components of the S&P 500 index is only 14.7%, significantly lower than the market value-weighted return level of 124.9% for the AI sector.

The excess returns of the AI sector in the US stock market are driven by the continuous realization of high economic expectations. Although the driving force behind the rise and fall of the split Nasdaq in 2023 is mainly valuation-driven, the increase in valuation is also supported by fundamentals. Benefiting from the wave of the AI industry, the market expects rapid growth in the performance of the US technology sector. Since the end of 2022, profit expectations for information technology and communications have continued to grow rapidly, catalyzing the early "valuation lifting" market. However, as the market continues to evolve, the ability of the US AI sector to sustain and steadily increase its valuation is mainly due to its ability to continuously meet market performance expectations. For example, the information technology industry recorded an EPS growth rate of 25.35% in 2024Q1, once again outperforming market expectations. It is worth noting that since 2024, the rise in the US technology sector has shifted from last year's "valuation lifting" to profit-driven, further emphasizing the importance of fundamentals.

The same is true for the A-share market, with companies like Zhongjixuchuang continuously breaking new highs in optical modules, also due to the continuous realization of high economic expectations. Zhongjixuchuang's net profit growth rates for 2023 and 2024Q1 were 77.6% and 303.8% respectively, with a consensus expected growth rate of 126.6% for 2024, continuous realization of high economic expectations, and continuous upward revision of expected EPS since last year.

Therefore, in an era of high success rate investments, economic prosperity is the core criterion for evaluating the technology market. It is more important to patiently invest in true technological growth rather than speculate on sectors or themes Risk Warning

Pay attention to fluctuations in economic data, unexpected policy tightening, unexpected interest rate hikes by the Federal Reserve, etc.

This article is reproduced from "Yao Wang Hou Shi", edited by Ye Zhiyuan from Wisdom Finance.