Last week saw a general pullback across major indices, with only the Shanghai Composite Index posting a slight gain. Looking at the primary Shenwan industries, banking, non-bank finance, and non-ferrous metals performed relatively well, while media, computer technology, and coal underperformed.

Macroeconomic Overview

Domestically, China's May CPI remained flat year-on-year at 1.2%, while the PPI rose to 3.9% year-on-year, further widening the gap between the two. For CPI, the year-on-year contribution from energy prices increased from 0.56 to 0.66 percentage points, remaining the primary driver. Core CPI decelerated to 1.1% year-on-year, indicating that rising oil prices have largely been contained within the energy supply chain and have not yet spread to a broader range of core consumer goods. Regarding PPI, the sequential peak impact from oil prices appears to have passed, while demand from the new economy and seasonal factors related to peak summer electricity demand continue to provide structural support. Overall, the main challenges are demand pressures and structural divergences, with improvements in domestic demand still reliant on further support from macro policies.

Internationally, the May US headline CPI met expectations, while the core month-on-month CPI was slightly below forecasts, leading to a slight easing in rate hike expectations. Specifically, US CPI rose 0.47% month-on-month in May, compared to 0.64% previously. Core CPI increased 0.21% month-on-month, down from 0.38%. Year-on-year, headline CPI was 4.25%, up from 3.81%, and core CPI was 2.85%, up from 2.75%. Aside from core CPI being slightly softer than expected, the May figures were largely in line with market consensus. The modest core month-on-month reading suggests the 'second-round effects' of oil prices on inflation are not yet significant. Following the data release, US Treasury yields edged up slightly. Major asset classes showed some relief from the tighter monetary policy expectations that followed the non-farm payrolls report, but the overall market reaction was muted.

In summary, core inflationary pressures in the US for May were relatively contained and did not further fuel market concerns about Federal Reserve rate hikes. It is anticipated that US inflation is unlikely to repeat the scenario of persistently exceeding expectations seen in 2021-2022 within this year.

Looking ahead, market liquidity pressures are expected to remain significant in June, potentially creating headwinds for risk assets. However, the threshold for the Fed to implement a rate hike this year remains high, given internal Fed divisions, the lack of significant pass-through of inflationary pressures, and political resistance to hikes in an election year. Key focus will be on the policy stance communicated by Fed Chair Waller at the June FOMC meeting.

Investment Approach

As uncertainty factors ease, a new window for a market uptrend is expected to open. This is based on several reasons. First, overseas uncertainty is diminishing: the peak point for the sequential acceleration in US inflation and tightening expectations may have already been reached. With the cooling of conflict in the Middle East and improvements in shipping, inflation expectations are likely to be revised down, and the Fed's decision on rates will also be finalized before the Dragon Boat Festival.

Second, growth expectations are being revised upward: strong Chinese export data for May not only addressed market skepticism but also suggests potential improvement in the interim reports of A-share listed companies. This reflects the substantial demand from global AI capital expenditure and energy transition, as well as supply chain shortages.

Third, there is potential for a confluence of incremental capital entering the market: the decline in risk-free returns is creating sustained wealth management demand and stronger support for the Chinese market. Furthermore, since June, announcements of reduced share sales by major holders, accelerated private fund filings, and public fund approvals are expected to translate into tangible incremental market entry capacity after the Dragon Boat Festival.

Regarding investment direction, the core themes of technology and manufacturing are favored, and industrial metals may also see rotational opportunities. Specifically:

1) Emerging Technology: Driven by US-China AI investment, capacity shortages, and accelerating technological iteration, with no visible turning point in inventory-to-sales ratios or ROIC, and valuations of core leading companies not yet stretched. Focus areas include integrated circuits, communication equipment, high-end equipment, and minor metals.

2) Competitive Manufacturing: Global AI investment and the energy transition are providing new historical growth opportunities for the globalization of Chinese enterprises. Focus areas include power equipment and new energy, engineering machinery, and innovative drugs.

3) Industrial Metals: Likely to benefit from a potential swing back in rate hike expectations following an oil price pullback and a recovery in economic demand. Coupled with their currently oversold positions, there is a high probability of capital rotation into this sector.

4) Traditional Sector Recovery: Favor sectors like banking, where micro-structural adjustments are clearing and valuation advantages are becoming prominent.