Chen Guo: "The key to 'anti-involution' is how to price it. If implemented properly, it may generate a new batch of dividend assets."

Summary

The expectation of "anti-involution" policies has strengthened, and it is difficult to falsify in the short term. The Central Financial Committee meeting in July 2025 emphasized "governing enterprises' low-price disorderly competition in accordance with laws and regulations, guiding enterprises to improve product quality, and promoting the orderly exit of backward production capacity." The policy has further clarified the shift from preliminary planning guidance to concrete efforts, with multiple industries such as automobiles, photovoltaics, cement, renovation materials, and papermaking responding to the call. We expect that in the next phase, including the Politburo meeting and the State Council meeting, there may be more "anti-involution" policy deployments. The possible methods, ranked from weak to strong in effect, include: 1) industry self-discipline & price monitoring; 2) market-led, strict control of production capacity; 3) administrative measures to force capacity reduction; 4) mergers and reorganizations, etc.

Historically, if the execution effect of "relief" on the supply side is falsified, the market will continue the previous fundamental trend; if the execution is good, it usually unfolds in two types of paths:

One is "stable prices" achieved through "controlling quantity," without significant capacity clearance. In this model, the industry index is expected to stop falling and stabilize, but absolute returns are not significant. Structurally, low-cost leaders perform better than second- and third-tier companies, as seen in cases like panels and fiberglass.

The second is a price increase type driven by capacity clearance and a continuously improving supply-demand pattern. Referring to the resource market catalyzed by supply-side reforms in 2016, it can be divided into two phases: 1) Supply contraction first drives valuation recovery, but the market fluctuates. In February 2016, policy promotion combined with the peak construction season led to a rebound in related resource prices, but with significant volatility. The sector's excess return lasted about one month before turning into fluctuations. 2) Improvement in demand and continuous price increases drive a trending market. The continuous price increase and excess return in resources started with the gradual confirmation of economic recovery in the second half of 2016. From the perspective of industry elasticity and sustainability, it is preferable to select sectors with better supply-demand patterns and stronger price control capabilities, such as cement, which performed overall better than steel in 2018-2019.

Which industries currently need "anti-involution"? Based on the turnover rate of fixed assets and net profit margin indicators, the sectors currently facing supply-demand excess and low prices mainly include: mid- and downstream manufacturing of [lithium batteries, photovoltaics, wind power, passenger cars, papermaking, medical devices], service/consumer sectors of [food processing, express delivery, small home appliances], resource materials sectors of [steel, cement/glass, consumer building materials, chemical fibers/pesticides, energy metals], and real estate chain sectors of [kitchen appliances, home furnishings], etc.

From the perspective of policy expectations, it is easier for detailed rules/measures to be introduced to constrain supply-side behavior in areas with [high state-owned enterprise ratios or high industry concentration]. In the "involution" sectors, those with a high proportion of state/central enterprises mainly include steel, coal chemical, cement, chemical raw materials, passenger cars, and fiberglass; while sectors where the proportion of state/central enterprises is below 50%, but the revenue CR3 of listed companies is relatively high, mainly include chemical fibers, silicon materials, aquaculture, inverters, express delivery, food processing, and renovation materials.

After thematic speculation and preliminary valuation recovery (historical review shows sustainability of about one month), the mid-term stock price performance depends on the ROE improvement path, and the reasonable space for PB recovery also depends on the expected steady-state level of ROE. At the same time, if "anti-involution" is effectively implemented, although the industry may not all achieve a V-shaped reversal from difficulties, it may generate a new batch of dividend assets Currently, the preliminary recovery of ROE has been achieved in the oversupply areas where the supply and demand pressure is not significant in Q1 2025. If the supply structure is further optimized, ROE is expected to rise again. Based on comprehensive assessments of profit expectations, attention can be paid to areas such as [wind power chain/inverters, fiberglass, steel, and aquaculture]. On the other hand, for sectors where the growth rate of fixed assets on the supply side remains high and ROE has not stabilized, such as photovoltaic/battery upstream, lithium, and polyurethane, more constraints may be needed to transition from supply-demand loosening to balance.

"Anti-Overcompetition": Strengthening Policy Expectations, What to Do?

The background of this round of "anti-overcompetition": At the macro level, the top-level design of policies focuses on "building a unified national market" and accelerating internal circulation. However, in recent years, local protectionism and market segmentation have led to inefficient allocation of resources and factors; at the meso level, after a significant expansion of corporate profits from 2020 to 2022, a new round of capital expenditure cycle has begun, with continuous new capacity being added and weakening demand expectations leading to intensified supply-demand pressure. The year-on-year growth rate of PPI has continued to decline since October 2022, and it has been negative for 33 consecutive months.

The expectation for the implementation of "anti-overcompetition" rectification measures has strengthened. In July 2024, the Politburo meeting first mentioned "preventing vicious competition of overcompetition," and subsequent meetings, including the Central Economic Work Conference in December 2024 and the National Government Work Report in March 2025, have continued to mention "comprehensive rectification of overcompetition." In July 2025, the Central Financial Committee meeting further emphasized "governing low-price and disorderly competition of enterprises in accordance with laws and regulations, guiding enterprises to improve product quality, and promoting the orderly exit of backward production capacity." Various industries, including automobiles, photovoltaics, cement, decoration materials, and paper-making, have responded to the call, and the expectation for policies to shift from planning guidance to concrete actions has become clearer.

In the second half of the year, price downward pressure may become more significant, and there is an urgent need to alleviate deflation concerns. The effectiveness of the "two new" policies is gradually declining, and the year-on-year decline in real estate sales has recently expanded again. If there is a lack of incremental policy support on the demand side, traditional economic sectors may face the risk of a second bottoming out of profits in the second half of the year, which will further exacerbate the pressure of weakening prices and deflation concerns. We expect that in the upcoming phase, both the Politburo meeting and the State Council meeting may make more "anti-overcompetition" policy deployments.

Similar to the supply-side reform 1.0 from 2016 to 2018, the current economy also faces structural oversupply and persistent PPI weakness. However, there are expected to be significant differences in terms of industrial fundamentals, "anti-overcompetition" policy measures, and final effects:

First, without demand-side policy coordination, the economy may struggle to withstand the stagflation risk caused by significant price increases in upstream resource products, and the intensity on the supply side is expected to be relatively moderate. In Q3 2021, under the influence of intensified supply-side control policies on energy consumption and the resurgence of demand-side pandemic effects, the economy entered a "quasi-stagflation" phase, with the year-on-year growth rate of PPI exceeding 10% in September, and the GDP growth rate for that quarter unexpectedly declined to 5.5% (previous value 8.1%, both are revised values) Second, the imbalance between supply and demand and the direction of rectification mainly focus on the mid-to-lower reaches of the manufacturing industry, where private enterprises are predominant and employment is dense, leading to more policy considerations.

Third, the proportion of backward production capacity has decreased, and it is difficult to define in some areas, with significant industry differentiation. After the "Supply-side Reform 1.0" rectification, the proportion of backward production capacity in sectors such as coal, steel, copper smelting, electrolytic aluminum, and cement has significantly decreased. The improvement in the supply side brought about by administrative measures is expected to be relatively limited compared to 2016-2018; in addition, the backward production capacity in emerging industries such as photovoltaics, lithium batteries, and automobiles is also difficult to define, which may be more about the replacement of technological routes and will rely more on industry self-discipline and market-oriented measures.

In terms of effectiveness, sorted from weak to strong, we expect the possible "anti-involution" methods to include:

Industry self-discipline & price monitoring: This can marginally improve the involution issue, but under the "prisoner's dilemma," if there are no specific identification standards and penalty details, the subsequent effects may not be significant. For example, 1) In October 2024, the CPIA organized 16 leading enterprises to reach a consensus on "price protection," clarifying the minimum cost of components at 0.69 yuan/watt and calling on enterprises to refuse bids below cost; however, in December, there was an incident where the bidding party ignored the cost line and insisted on low-price bidding, ultimately two companies were shortlisted with bid prices of 0.625-0.631 yuan/watt. 2) In March 2024, the China Iron and Steel Association called on enterprises to self-discipline to control production and reduce inventory, but from March to June, the operating rate of sample steel mills continued to rise, leading to delayed inventory reduction and continued price decline.

Market-oriented dominance, strict control of production capacity, etc.: This is applicable to industries such as cement and electrolytic aluminum, where private enterprises account for a high proportion. Historically, administrative measures mainly established industry order through capacity replacement, energy efficiency standards, and other rules to avoid arbitrariness in administrative intervention, such as in electrolytic aluminum and cement from 2016 to 2018.

Administrative measures to forcibly reduce production capacity: For example, forcibly closing non-compliant enterprises, applicable to industries with a high proportion of state-owned enterprises. For instance, 1) In 2016, the "Opinions on Resolving Overcapacity in the Steel Industry and Achieving Sustainable Development" proposed to reduce crude steel capacity by 150 million tons within five years, with capacity reduction tasks allocated by region; 2) The "State Council's Opinions on Resolving Overcapacity in the Coal Industry and Achieving Sustainable Development" in 2016 clearly stated that 500 million tons of capacity should be exited and 500 million tons should be reduced and restructured within 3-5 years, with exit indicators allocated by province. The short-term effects of the policy are significant.

Mergers and acquisitions: Avoid vicious competition while eliminating the backward production capacity of integrated enterprises. Successful cases are usually led by state-owned enterprises, such as the Baowu merger and the Shanxi Coking Coal Group integration. If the industry concentration can be significantly improved, the mid-term effects will be the best, such as in coal.

Historical Review, Different Pricing Models for Supply-side Improvement Clues

Historically, the varying effects of policy promotion have also determined the differences in subsequent market performance. If the execution effect is falsified, the market will continue to follow the previous fundamental trend direction; If successful, there are generally two types of interpretation paths:

One is "controlling quantity" in exchange for "stabilizing prices," without significant capacity clearance: In this model, the industry index is expected to stop falling and stabilize, but absolute returns are not significant. Structurally, low-cost leaders perform better than second and third-tier companies. Looking at two cases: 1) Panels: Affected by significant losses in the first three quarters of 2022, panel manufacturers began to control quantity to maintain prices from Q4 2022, and continued to support prices by adjusting operating rates. The price of LCD battery panels stopped falling in September and has remained stable since 2023. The Shenwan three-tier panel industry also successfully turned losses into profits in 2024. With the stabilization of the main product prices, the Shenwan panel index bottomed out in Q4 2022 and has since continued to fluctuate at low levels, with the leading company BOE A's stock price performing overall better than the industry index. 2) Glass fiber: Starting in March 2024, the industry leader China Jushi issued a price adjustment notice, signaling a "reverse involution," and other companies followed suit. From Q4 2024, the net profit attributable to the parent company in the Shenwan glass fiber industry returned to positive growth on a month-on-month basis. In terms of stock price performance, China Jushi's price increase led to significant excess returns in January (April 2024). Although subsequent industry inventory increases caused temporary fluctuations in the industry index and leading stock prices, they remained in a low and stable range.

The second type is price increases due to capacity clearance and continuous improvement in the supply-demand structure: Supply contraction first drives valuation recovery, but the market is volatile; improvement in demand and continuous price increases are needed to drive subsequent trending markets. Historically, the trend of price increases in resource products is not solely driven by supply digestion but also relies on demand-side cooperation. Looking back at the resource product market catalyzed by supply-side reforms in 2016, it can be divided into two phases: 1) In February 2016, policy promotion combined with the peak construction season led to a rebound in the prices of resource products such as steel, cement, and coal, but with significant volatility; the market performance showed that the excess return trend in related sectors lasted for about one month (February to March 2016) before turning into fluctuations. 2) As the year progressed into the second half of 2016, the year-on-year growth rate of real estate investment stabilized and rebounded, PMI steadily increased, and economic recovery gradually confirmed, leading to a trend-based warming of prices for steel, coal, and cement, which also drove continuous excess returns in related sectors (generally extending into 2017).

From the perspective of industry elasticity and sustainability, it is preferable to select sectors with better supply-demand structures and more favorable industry competition patterns (which affect price control capabilities). For example, in the market from H2 2016 to 2017, under the same expected degree of supply digestion, the price elasticity was steel > coal (due to different demand); in terms of market sustainability, cement, due to its more stable profitability and higher concentration, continued to fluctuate upward until H1 2020, while steel began to decline first as the economic cycle peaked in 2018.

Returning to the Present, Who Benefits More?

Which industries currently need "anti-involution"? As of Q1 2025, based on the criteria of industry fixed asset turnover rate TTM being below the 30th percentile since 2016, and sales net profit margin TTM also being below the 30th percentile or showing negative growth, the sectors currently facing oversupply and low prices mainly include: mid-to-low-end manufacturing such as【lithium batteries, photovoltaics (net profit margin TTM negative growth), wind power, passenger vehicles, paper (net profit margin TTM negative growth), medical devices】, service/consumer sectors such as【food processing, express delivery, small home appliances】, resource materials sectors such as【steel (net profit margin TTM negative growth), cement/glass, consumer building materials, chemical fibers/pesticides, energy metals】, and real estate chain sectors such as【kitchen appliances, home furnishings】.

From the perspective of policy expectations, the directions where measures/details are more likely to be introduced are concentrated in areas with【high state-owned enterprise ratios or high industry concentration】. Using the operating income TTM of all A-share listed companies as a base, we calculated the CR3 data for each Shenwan secondary/tertiary industry classification. After sorting, in the "involution" areas where the fixed asset turnover rate TTM is below the 30th percentile since 2016, the sectors with a high proportion of state/central enterprises mainly include steel, coal chemical, cement, chemical raw materials, passenger vehicles, and fiberglass manufacturing, which are more likely to adopt administrative measures to promote "anti-involution"; while sectors with a state/central enterprise proportion below 50%, but with a high CR3 in listed company revenue, mainly include chemical fibers, silicon materials, aquaculture, inverters, express delivery, food processing, and renovation building materials. If "anti-involution" is pursued through industry self-discipline or mergers and acquisitions, the obstacles to progress are correspondingly smaller.

After thematic speculation and preliminary valuation repair (historical review continuity lasts about 1 month), the mid-term stock price development path will depend on the path of ROE improvement, and the reasonable space for PB repair will also depend on the expected steady-state level of ROE. The excess return market driven by policy expectations or initial price increases lasts about 1 month (examples from resource products in 2016, fiberglass in 2024), and the subsequent sector performance will vary depending on the elasticity of ROE repair. Low-cost leaders (price improvement) and strong demand areas (volume improvement) are two directions with relatively high certainty of mid-term benefits, while sectors that still face significant supply pressure have a higher probability of being falsified.

Currently, in the oversupply areas that have achieved preliminary ROE repair in Q1 2025, and where subsequent supply pressure is not significant, if the supply structure is further optimized, ROE is also expected to rise to a new level. At the same time, if "anti-involution" is effectively implemented, although not all industries may achieve a V-shaped reversal from difficulties, it may generate a new batch of dividend assets. In the oversupply areas where the fixed asset turnover rate TTM has been below 30% since 2016, using the conditions of Q1 2025 ROE (TTM) showing a relatively high quarter-on-quarter repair amplitude + Q1 2025 fixed asset year-on-year growth < 15%, combined with profit expectations for comprehensive assessment, You can pay attention to sectors such as [wind power chain/inverters, fiberglass, steel, aquaculture].

On the other hand, for sectors such as photovoltaic/battery upstream, lithium, and polyurethane, where the growth rate of fixed assets on the supply side remains high (>15%) and ROE has not yet stabilized, transitioning from supply-demand loosening to balance may still require more constraints.

Article authors: Chen Guo, Zheng Jiawen, source: Chen Guo Investment Strategy, original title: "Anti-involution: What Matters is How to Price [Dongfang Caifu Strategy Chen Guo Team]"

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