CITIC SEC has released a research report stating that at the index level, the room for further valuation recovery is limited. The key to sustaining the A-share bull market in the next phase lies in the rebound of corporate profit margins. Global supply chain disruptions present another opportunity to reassess the pricing power of China's dominant manufacturing sectors. From an industrial trend perspective, the phenomena of code inflation and physical scarcity are manifesting in China as an enhancement in the pricing power of its leading manufacturing industries. Disruptive AI innovation and global energy supply chain disturbances are accelerating this trend. In terms of allocation, the firm advises a steadfast focus on sectors where China's manufacturing advantages are being repriced—such as chemicals, non-ferrous metals, power equipment, and new energy—with price increases remaining a core trading theme. Additionally, increasing exposure to low-valuation factors, including insurance, securities, and utilities, is recommended. From a short-term perspective driven by景气 signals, price hikes continue to be the most potent driver in the first quarter. The Iran-Israel conflict and potential closures of the Strait of Hormuz are expected to temporarily elevate the central price of oil, shifting cost curves for numerous cyclical products rightward. This narrative offers multiple investment线索 and structural opportunities: 1) Chemical products with alternative raw material or process routes that benefit from oil price shocks; these products in China often have higher "coal content" compared to international competitors, leading to significant price differentials when primary raw material costs rise. Examples include urea, MDI, PVC, spandex, and coal chemical products. 2) Products with significant production capacity concentrated in the Middle East or Western Europe, where supply disruptions could create additional supply-demand gaps and fuel涨价 expectations. This category includes methanol, sulfur, electrolytic aluminum, oil and gas, tanker shipping, and industrial gases. 3) Substitutes that experience price increases due to cost pressures and rising demand, such as coal. 4) Products already in an涨价 phase where cost increases provide a window for price pass-through in tightly balanced markets, including pesticides, polyester filament, dyes, oil refining, lithium battery anode materials, and separators.

The core views of CITIC SEC are as follows: Geopolitical turbulence coincides with indices reaching critical levels, making spring a period for信心重塑 and decisive index movements. 1) The second quarter represents a crucial window for信心重塑 on the path of the A-share慢牛. Whether examining indices, valuations, or macro liquidity, A-shares stand at a pivotal juncture this spring. The monthly chart of the Shanghai Composite Index is testing a 20-year resistance line dating back to October 2007—whether it holds or retreats will significantly impact investor信心. After a year and a half of bull market, valuation percentiles for major broad-based indices have climbed, with most above the 80th percentile compared to the past decade, suggesting limited apparent revaluation space. Meanwhile, Middle East conflicts pose significant negative shocks to global supply chains and financial conditions, restraining risk appetite improvement. However, the static appearance of prolonged gains, rich valuations, and high levels coexists with historically low profit margins across many industries—this dichotomy between expensive valuations and weak profitability is the most prominent structural feature of the current market. At the broad index level, net profit margins for the CSI 300, CSI 500, CSI 800, and CSI 1000 stand at the 82.8th, 35.9th, 51.5th, and 14.0th percentiles since 2010, respectively. Should profit margins revert to historical medians, valuation percentiles would all fall below median levels. Comparing Chinese industry leaders with U.S. peers reveals substantial room for profit margin expansion. If one acknowledges that the future profit ceiling for China's leading manufacturers is the global TAM, this gap itself implies significant potential upside.

2) Sustained stabilization and recovery of corporate profit margins are the necessary prerequisite for continuing the A-share bull market. For indices to advance further, valuation alone is insufficient; the core determinant is whether China's dominant manufacturing sectors can systematically convert market share advantages into lasting profit margin improvements. If validated, this would reshape the market perception of A-shares' "short bulls and long bears" pattern over the past two decades. From a policy-driven industrial development perspective, the core of the "15th Five-Year Plan" industrial strategy is transitioning "from large to strong"—shifting from scale expansion driving industrialization and urbanization to stabilizing supply chains, preserving profits, and managing risks. The essence is for dominant manufacturers to enhance quality and efficiency to generate profits, which can then fund technological upgrades, ultimately achieving sustainable improvements in living standards and social security. Profitable dominant industries are the starting point and prerequisite for this policy logic. From a deeper fiscal perspective, growth in value-added tax based on production expansion and land revenue growth from accelerated urbanization are inevitably slowing. From 2019 to 2025, China's fixed asset investment growth averaged 2.4% annually, turning negative historically in 2025, while VAT plus business tax growth fell to 1.7% annually—both below nominal GDP growth and fiscal expenditure growth. For fiscal sustainability and controllable debt levels, promoting moderate price expansion, boosting corporate profits, and increasing household income to raise direct tax growth are necessary measures. From this angle, alignment between fiscal interests and shareholder interests is likely to strengthen. In market terms, one of this year's most important investment themes is going long on PPI and CPI.

3) Rapidly rising oil prices provide an opportunity to test the pricing power of China's dominant manufacturers. Since first proposing the revaluation of Chinese manufacturing pricing power last year, aside from categories directly boosted by North American AI infrastructure, stock gains in chemicals, non-ferrous metals, power equipment, and new energy have largely reflected narrative acceptance and anticipatory pricing. Simply pointing to stock price increases doesn't validate the narrative logic; substantial sector advancement requires sustained earnings confirmation and tangible fundamental evidence of pricing power revaluation. The energy cost shock from the Middle East conflict offers a window to observe and verify whether China's dominant manufacturers can structurally demonstrate pricing power. Analyzing petrochemical products along essential needs like clothing, food, shelter, and transportation reveals that most companies in these sectors have experienced pullbacks recently, while corresponding commodity prices have risen significantly in both spot and futures markets. This reflects market pessimism about midstream companies' ability to pass through costs, even though Chinese firms dominate global market share. The second quarter may provide more evidence to distinguish between two narratives: whether high crude import dependency and intense domestic competition compress manufacturing margins, or whether industries where China already holds monopolistic global share begin consistently passing cost pressures onward. The petrochemical chain serves as an ideal observation case, potentially repeating the order转移 to China seen after 2020-2021 global supply chain disruptions.

Against the backdrop of rising global energy costs and weakening financial conditions, low valuations and pricing power are the two most critical factors. 1) Historical analysis of major Middle East conflicts and oil price spikes shows that low valuations provide the strongest shield. During past significant geopolitical conflicts and oil supply disruptions, global equity market performance has varied. For instance, during the 1970s oil crises, U.S. stocks experienced a major valuation correction in 1973-1974 but rose 35% in 1979-1980. The 2022 Russia-Ukraine conflict, combined with Fed tightening, saw the S&P 500 fall 11.6% over four months while the Nikkei 225 gained 0.68%. Theoretically, Asia-Pacific markets are more oil-dependent and sensitive to dollar liquidity; the key difference then was valuation, with Japanese stocks being sufficiently cheap. The core strategy for navigating rising global energy costs and weaker financial conditions favors low valuations over high valuations, value over growth, and large caps over small caps. Recognized and priced-in景气度 may be relatively vulnerable factors in such an environment.

2) Inflation pressures and liquidity environment uncertainties act as catalysts for style rotation this year. As the Middle East situation transitions from acute conflict to sustained supply chain disruption, and traditional crisis response mechanisms lose effectiveness, markets must treat elevated inflation risks and deteriorating global liquidity as environmental variables until crisis resolution and supply chain restoration occur. This implies rotating from small caps to large caps, from thematic stocks to quality performers, and from high valuations to low valuations. Complex博弈 based on marginal geopolitical developments holds limited significance now. As of March 13, the ratio between the收盘价 of the small-cap SZSE 2000 Index and large-cap CSI 300 Index stands at 2.34, at the 98.8th percentile over three years. The excess return of profitable stocks over loss-makers is at the 1.3rd percentile over five years, indicating substantial accumulated outperformance by loss-making stocks in recent years. The net value of low-valuation factor long-short portfolios sits at the 17.1st percentile over three years, nearing historical extremes. From a long-cycle perspective, small caps and thematic stocks have enjoyed five years of relative outperformance, approaching historical duration limits in A-share history. In recent years, incremental fund flows into A-shares have been structurally imbalanced—abundant in配置型 and交易型 capital but scarce in stock-picking funds. Combined with减持 restrictions and ample liquidity, this has created structural mispricing accumulation alongside the low-volatility慢牛, issues that may gradually emerge following the Middle East conflicts.

Code inflation and physical scarcity manifest in China as enhanced pricing power for dominant manufacturers. 1) Employment structure makes China less vulnerable to direct demand shocks from disruptive AI innovation. Since GPT-4's emergence, market understanding of AI has evolved through three phases: initial vague expectations for AGI and killer apps, recognition of practical applications and productivity leaps from推理 demand explosion, and realization that AI's economic benefits remain limited while potentially disrupting traditional enterprise services and employment structures. Estimates suggest conversion rates for AI product recommendations are below 1%, significantly lower than e-commerce averages. The asymmetric impact of AI development on production versus actual payment is a reality with potentially more lasting and profound market implications than Middle East conflicts. However, China's employment structure renders it less susceptible to AI disruption compared to the U.S. and Europe. Service sector employment shares are 48.8%, 79.0%, and 73.5% for China, U.S., and Europe respectively. Within services, producer services account for 16.2%, 34.3%, and 32.0% of employment, significantly lower in China. Meanwhile, physically interactive services employ 48%, 41.8%, and 26.0% respectively, markedly higher in China. Thus, AI's impact on Western economies resembles China's post-2021 economic adjustment—weakening marginal income and employment prospects for the middle class—while China's most AI-vulnerable producer services have already undergone deep adjustments.

2) Global markets seek HALO assets, but China's focus is on manufacturing pricing power enhancement. The global trend of "code inflation, physical scarcity" is gaining momentum, but emphasis differs between China and the U.S. Overseas HALO investing focuses on defensive stocks that can withstand AI disruption without free cash flow impairment or ROIC degradation—essentially a passive defensive rotation. China's logic differs: the core theme is resource and manufacturing leaders with market share and competitive advantages proactively managing future capex节奏, converting existing advantages into pricing power and margin recovery, thereby restarting free cash flow expansion after low-return capex peaks. The essence is identifying industries and companies with hard-to-replicate global capacity, where massive market share advantages gradually translate into external price pass-through under government capacity control, improving profitability and cash flow. This forms the core logic for持续 recommending chemicals, non-ferrous metals, power equipment, and new energy. This represents a proactive value revaluation thesis with greater resilience, sustainability, and certainty than overseas counterparts. Applying the HALO framework to A-shares shows no clear valuation difference between high and low HALO score portfolios, nor significant outperformance since 2025. The HALO concept isn't directly applicable to A-shares as it is in North America.

For allocation, maintain a firm focus on sectors where China's manufacturing pricing power is being revalued. Current core holdings should prioritize industries where China holds market share advantages, overseas capacity reset costs are high and difficult, and supply elasticity is policy-sensitive—primarily chemicals, non-ferrous metals, power equipment, and new energy. While investors may worry about dollar strength pressuring non-ferrous metals near-term, medium-term Middle East instability is accumulating, exacerbating traditional petrodollar and dollar system shortcomings and actually accelerating the erosion of dollar competitiveness. Short-term dollar strength is inevitable given weaker euro and yen, while structural RMB share gains remain distant. Once global RISK OFF subsides, non-ferrous metals will repricing cost pressures, supply-demand gaps from reindustrialization trends, and resource security. Beyond these core holdings, increase exposure to low-valuation factors, focusing on insurance, securities, and utilities. From a short-term景气 signal framework, price increases remain the sharpest spear in Q1. The Iran-Israel conflict and Strait of Hormuz disruptions may temporarily elevate oil price centers, shifting cost curves for many cyclical products rightward, creating multiple线索 and structural opportunities under this narrative.

Risk factors include intensified摩擦 in technology, trade, and finance; tighter-than-expected domestic and international macro liquidity; and further escalation of conflicts in regions like Russia-Ukraine and the Middle East.