Xingzheng Strategy: External shocks' impact on A-shares is gradually diminishing; focus on opportunities with confirmed economic prospects

1. Overall, the market is pricing in “stagflation” and “escalating conflict intensity,” which may not be the final outcome of this round of conflicts.

This week, with no signs of easing in US-Iran tensions, two core concerns triggered a market-wide adjustment and rapid sector rotation. On one hand, the market is beginning to price in a prolonged conflict stalemate and high oil prices leading to “stagflation” expectations, as well as the liquidity tightening pressures from the Fed delaying or even reversing rate cuts. These have become the main contradictions in asset pricing recently. On the other hand, the market is also quickly rotating structurally in response to marginal changes in conflict intensity—defensive assets outperform when tensions heat up, while technology stocks lead the recovery when tensions cool.

Regarding the current two core market concerns—economic “stagflation” and “escalating conflict intensity”—and the potential systemic risks to the stock market, we believe this may not be the final outcome of this conflict cycle. Recent market adjustments have already priced in considerable pessimism, and there remains a significant “expectation gap,” which could present opportunities for market recovery after the correction.

First, concerning the transmission of high oil prices to the economy, inflation, and policy stance, the market currently compares the situation to the 1970s US oil crises and the 2022 Russia-Ukraine conflict. However, we see clear differences in terms of economic cycle position, inflation sensitivity to oil prices, and the demand-driven price increases:

• The first two oil crises and the Russia-Ukraine conflict occurred when the US was already in an inflationary cycle, directly influencing the Fed’s monetary policy response to oil shocks. In contrast, before this round of shocks, inflation was generally controllable, and the likelihood of rate hikes remained low. Historically, before the 1970s oil crises and the Ukraine conflict, US inflation was already above 5%, prompting the Fed to prioritize inflation control and tighten monetary policy, suppressing equities. Currently, US CPI YoY remains at a low 2.4%, similar to levels in 2003 (Iraq war), 2011 (Libyan civil war), and even during the third oil crisis when inflation was higher, the Fed maintained an accommodative stance, supporting equities over the medium to long term.

• The biggest difference from previous crises is that the sensitivity of the US economy and inflation to oil prices has significantly decreased. The era of oil prices solely dominating economic and asset prices is over. Since the post-crisis energy transition and the 2010 shale oil breakthrough, the US has shifted from being the largest oil importer to a net exporter, reducing the energy component in CPI and softening the impact of high oil prices on the economy and inflation. The era where oil prices alone dictated economic and policy outcomes has ended.

Third, unlike during the 2022 Russia-Ukraine conflict, when strong domestic demand and smooth price transmission supported inflation, the current US PPI-to-CPI transmission lacks sufficient demand support, further easing the inflationary impact of high oil prices. Before 2022, US consumers benefited from large direct cash subsidies, and post-pandemic demand surged, allowing upstream high oil prices to pass through to consumer prices. In 2011, despite high oil prices boosting US PPI, the transmission to CPI was limited due to weak consumer demand after the global financial crisis. This cycle, after sustained high interest rates since 2022, shows weakened consumer purchasing power, and the PPI-to-CPI transmission lacks demand support. The Fed’s monetary policy remains primarily driven by CPI. The market’s expectation of inflation rising due to the February PPI increase reflects a significant “expectation gap.”

Therefore, these differences suggest that “stagflation” may not be the ultimate scenario. The Fed is likely to remain cautious in the short term, with a high probability of continuing rate cuts in the second half of the year. The current market’s overly pessimistic policy expectations are expected to gradually correct. According to calculations by the Industrial Securities macro team, if WTI oil prices stay at $70/$80/$90/$100 per barrel through the end of the year, the US CPI YoY central tendency would be approximately 2.87%/3.08%/3.30%/3.51%. Considering that 3.5% is the lower bound of the current federal funds rate, inflation remains controllable. The market’s implied first rate cut is now pushed back to September next year, with some rate hike expectations embedded, reflecting a pessimistic outlook. As expectations for rate cuts rebound, the recovery space for equities will open up.

For China, the previous adjustments in A-shares during oil supply shocks mainly stemmed from domestic inflation pressures prompting monetary tightening (2003, 2011) or from external rate hikes combined with weak domestic demand creating a “domestic and external dilemma” (2022). This cycle, with the Fed maintaining easing, and relatively low domestic inflation, indicates no active monetary tightening risk. Moderate inflation supports nominal economic growth and corporate profits, maintaining the fundamental basis for this bull market.

Finally, regarding the future development of this conflict, we maintain the view that “escalation is for better de-escalation.” Short-term escalation may eventually create opportunities for de-escalation. With the US threatening to destroy power plants, deploying troops, issuing ultimatums, and Iran retaliating by blocking the Red Sea and attacking oil facilities, the market may initially see geopolitical premium expansion. However, mid-term, such expansion may face obstacles. The US’s political goal has shifted from regime change in Iran to reopening the Strait of Hormuz, with negotiations being easier to achieve than military victory. Therefore, whether it’s troop buildup or island seizures, the core aim is maximum pressure on Iran to unblock the strait. Continued escalation may not be the final outcome; negotiations remain the baseline. If escalation persists, high oil prices and tactical setbacks for the US military could increase Trump’s willingness to negotiate, creating a de-escalation opportunity.

In summary, recent market adjustments mainly stem from two concerns: 1) the risk of economic “stagflation,” and 2) the risk of uncontrolled escalation of conflict intensity. Both may not be the final outcome of this cycle. Short-term escalation could trigger de-escalation, often when market sentiment is most pessimistic. In the medium to long term, “stagflation” might be the most pessimistic scenario for the economy, but it is not necessarily the baseline. The market’s current pessimistic pricing provides a foundation for medium- to long-term recovery.

2. Structurally, the market has already chosen the direction for us: performance-driven sectors remain the focus of “performance certainty” in the recovery phase.

Structurally, the market has effectively selected a “winning amidst chaos” approach. We analyzed the top-performing sectors in A-shares since the US-Iran conflict began, summarized into three main themes:

• Sectors with strong earnings certainty and solid growth logic: represented by North American computing power chains (communications equipment, components).

• Beneficiaries of higher oil prices and price transmission: new energy (batteries, EVs, photovoltaics, wind power), coal, utilities (electricity, gas), agricultural products.

• Defensive sectors leading risk aversion: banks, consumer staples, home appliances, infrastructure.

Meanwhile, the “price-increase chain” (oil, chemicals), which is highly correlated with oil prices and has received much attention, has underperformed or experienced high volatility, with poor holding experience. This is partly due to short-term fluctuations driven by conflict sentiment and partly because some funds have realized gains since early this year. More importantly, many stocks driven by oil prices reflect cost increases rather than genuine profit growth; rising oil prices may erode industry margins, especially downstream oil sectors. As earnings disclosures approach and the market shifts focus to “real” growth, attention will likely turn from mere price-increases driven by oil to sectors with confirmed growth and real beneficiaries.

Looking ahead, as external shocks to A-shares diminish and performance focus shifts to growth, we see three potential developments:

1. For growth-oriented tech and export-linked stocks, after initial valuation discounts due to geopolitical and liquidity concerns, their independent industry trends and relatively low oil sensitivity could make them the focus of market attention, with more high-quality stocks outperforming.

2. For the “price-increase chain,” with more signs of price hikes in Q1, overall growth prospects may be validated by earnings reports, becoming an important growth signal beyond tech. However, internal differentiation is likely, especially among oil-driven price-increase stocks.

3. For dividend and domestic demand stocks driven mainly by risk sentiment, if earnings fail to confirm growth during earnings season and conflicts de-escalate, their excess gains are likely to decline gradually.

In terms of allocation, based on upward revisions of profit forecasts for 2026 since the start of the year, sectors expected to perform well in Q1 include:

• AI: hardware (consumer electronics, components, computing devices, communication equipment, electronic chemicals), software (gaming, digital media, IT services).

• Advanced manufacturing and export chains: new energy (batteries, photovoltaics, wind power), military industry (marine equipment), machinery (rail transit, specialized equipment, construction machinery), commercial vehicles, home appliance parts, medical services.

• Cyclical price-increase chains: non-ferrous metals, coal, steel, chemicals (rubber), building materials (glass fiber), shipping ports, gas.

• Consumer & financials: agriculture, retail, jewelry, securities.

Among these, sectors with relatively low gains since early this year include North American computing power chains (communications equipment, components), mid-to-lower stream AI (gaming, digital media, AIGC beneficiaries), manufacturing & export chains (consumer electronics, batteries, commercial vehicles, home appliance parts, innovative drugs), cyclical & price-increase chains (non-ferrous metals, steel, agricultural products, gas). From the perspective of oil price benefits, the top pick is new energy, which combines export growth and energy substitution logic. For cyclical & price-increase chains, coal, agricultural products, and gas with upward revisions are also worth attention. For growth certainty, focus on North American & domestic computing chains (CPO, PCB, domestic semiconductor industry) and AI sectors with large expectations gaps (gaming, digital media, AIGC beneficiaries, cloud service-driven segments). For low positions, previously adjusted stocks like innovative drugs are recommended.

Risk warnings

Fluctuations in economic data, policy easing below expectations, Fed rate cuts below expectations, escalation of geopolitical tensions, etc.

(Source: Industrial Securities)