Big Switch, Ready to Go

Report Introduction

The current operating conditions of domestic manufacturing enterprises are improving, as confirmed by industrial enterprise operating data and semi-annual reports. The upward pressure of overseas inflation is easing, and future interest rate cuts by the Federal Reserve will support the recovery of global manufacturing. There are already signs of a shift in overseas equipment investment from AI to traditional manufacturing. From a global supply and demand perspective: the past expansion of Chinese commodity production + contraction of overseas commodity demand is transitioning to China's production reversing the trend + overseas investment driving the expansion of commodity demand; from the perspective of monetary policy and Chinese production, the combination of global monetary tightening + Chinese production expansion is shifting to global monetary expansion + slowing Chinese production, with China's re-inflation imminent.

Summary

■ The Eve of Change: Between Large and Small, High and Low

Since last week, the shift from small-cap superiority to large-cap superiority has spread from within the growth sector to the entire market; in the past two weeks, undervalued stocks have outperformed overvalued stocks across the A-share market. Currently, the valuation gap between small-cap and large-cap stocks remains significant, whether it is the PE valuation ratio of the China Securities 2000 and the ChiNext Index in the growth sector, or the PE valuation ratio of the CSI 1000 and the CSI 300 in the broad-based indices, both are at historical highs. In the short term, the market has shifted towards cyclical investments, but is currently only willing to embrace the AI-related industrial chain where the industrial trend is clearer. If there are clearer signals of profit improvement in low-valued assets, a broad style switch will occur.

■ Domestic: Profit Bottom is Emerging, Unit GDP Profit Will Rise Again

The industrial enterprise operating data for July once again confirmed the support of reversing the trend for the improvement of domestic manufacturing profitability. Despite a slight slowdown in revenue growth, the total profit growth of the manufacturing sector has expanded, and the decline in accounts receivable growth indicates that the issue of corporate payment terms is further alleviating. Currently, the domestic manufacturing sector shows a state where profit growth > revenue growth > inventory growth, suggesting that the inventory cycle may be nearing its end. Since the second quarter, there have been significant de-inventory characteristics in the mid-to-downstream equipment manufacturing and downstream consumer goods manufacturing sectors, with a rebound in profit share; the profit share of upstream resource products has declined but shows internal differentiation, with coal and oil and gas extraction being the main drag. From an industry perspective, the fundamentals of black metal mining, non-ferrous metal mining, cultural and artistic manufacturing, automobile manufacturing, and pharmaceutical manufacturing have improved relatively well, with both revenue growth and profit margins increasing since the second quarter. The improvement in domestic fundamentals is also reflected in the semi-annual reports of listed companies: the ROE (TTM) of the entire A-share non-financial real estate sector in Q2 2025 is marginally rising, with year-on-year growth in operating cash flow and its proportion of revenue continuously rebounding; at the same time, the year-on-year growth of inventory and capital expenditure/depreciation are at their lowest levels since 2010. If demand recovers in the future, the pressures of inventory and new production capacity may no longer be the core factors restricting price elasticity.

■ Overseas: Interest Rate Cuts Support Global Manufacturing Recovery, Breaking the Singular Dominance of AI Investment

This week, the U.S. PCE inflation data met expectations, and the consumer confidence index declined. The easing of inflationary pressures has further matured the conditions for the Federal Reserve to begin cutting interest rates. The current market expectation is that the Federal Reserve will start cutting rates in September, with more than two rate cuts expected within the year The opening of the interest rate cut cycle is conducive to the recovery of fixed asset investment and manufacturing activities in the United States. Recently, the year-on-year growth rate of non-residential construction spending in the U.S. has rebounded, with utility-related construction investment activities being relatively more active among the subcategories. Empirically, the growth rate of equipment investment in the U.S. is highly correlated with the growth rate of durable goods shipments. Recently, the shipment volumes of primary metals, industrial machinery, and generators in the U.S. have increased relatively quickly, indicating that traditional manufacturing equipment investment activities in the U.S. may be quite strong. However, it is worth noting that the growth rate of shipments of computer storage devices, which are more closely related to AI investment, has shown a marginal decline. Combined with the recent quarterly report data from NVIDIA, which showed that data center revenues fell short of expectations and year-on-year growth declined, it appears that investment related to AI infrastructure in the U.S. may have begun to slow down.

■ Major Switch, Just Around the Corner

From the perspective of global commodity supply and demand changes: it is transitioning from a combination of China's commodity production expansion + overseas commodity demand contraction to a combination of China's production de-involution + overseas investment-driven commodity demand expansion; from the perspective of monetary policy and China's production, it is shifting from global monetary policy tightening + China's production expansion to global monetary expansion + China's production slowdown, indicating that China's re-inflation is imminent. In this regard, our recommendations are: First, physical assets that benefit from improved operating conditions due to domestic de-involution, recovery of overseas manufacturing activities, and accelerated investment: industrial metals (copper, aluminum, steel), raw materials (glass fiber, basic chemicals, steel), and capital goods (construction machinery, specialized machinery, mechanical components, heavy trucks); Second, the long-term asset side of insurance will benefit from a rebound in capital returns, followed by brokerages; Third, after profit recovery, opportunities will also emerge in domestic demand-related sectors, with the market expansion unfolding. The repair of A-share heavyweight stocks has just begun, and we recommend paying attention to: food and beverage, power equipment.

Main Text

1. The Eve of Style Switching

Since last week, the shift from small-cap superiority to large-cap superiority has spread from within the growth sector to the entire market. The ChiNext Index continues to outperform the CSI 2000 Index, while the CSI 300 Index has also begun to outperform the CSI 1000 Index. Currently, the valuation gap between small-cap stocks and large-cap stocks remains significant, whether in terms of the PE valuation ratio between the CSI 2000 and the ChiNext Index in the growth sector, or the PE valuation ratio between the CSI 1000 and the CSI 300 in broad-based indices, both of which are at historical highs. The shift from small-cap style to large-cap style is essentially a transition from high valuation to low valuation.

In the past two weeks, the combination of stocks with valuation percentiles below 20% has begun to outperform those with valuation percentiles above 80% across the entire A-share market, and the phenomenon of high and low valuation cuts is more pronounced in the growth sector represented by TMT, which has overall higher valuations. In a previous report titled "Valuation Constraints and Profit Potential," we pointed out that the stock market faces valuation constraints when it anticipates improvements in fundamentals. The current phenomenon of the shift from small-cap style superiority to large-cap style superiority, and from high market capitalization to low market capitalization superiority, indicates that investors are gradually recognizing the issue of valuation constraints In the short term, the market has shifted towards growth investments, but currently, it only dares to embrace the AI-related industrial chain where the trends are clearer. If there are clearer signals of profit improvement in low-priced assets, a broad style switch will occur.

2. Domestic: The profit bottom is emerging, and the profit per unit GDP will return to a rapid rise

From the industrial operation data of July released this week, the continuous advancement of anti-involution has further confirmed the improvement in the profitability of domestic manufacturing: while the year-on-year growth rate of cumulative revenue has slightly slowed down, the year-on-year growth rate of total profits in manufacturing has actually expanded; moreover, the year-on-year growth rate of accounts receivable in manufacturing enterprises has continued to decline, indicating that the issue of account periods for enterprises has further eased. Currently, the manufacturing sector is showing a state where profit growth rate > revenue growth rate > inventory growth rate, suggesting that the inventory destocking may be nearing its end and is transitioning from passive destocking to active restocking.

From the perspective of different links in the industrial chain, since the second quarter, the destocking characteristics in the mid-to-lower reaches of equipment manufacturing and downstream consumer goods manufacturing have become more pronounced. The profit share of mid-to-lower reaches of equipment manufacturing has continued to rise, while the profit share of upstream resource products has decreased. However, it is worth noting that there is actually differentiation within upstream resource products; the profit margins in the black metal mining and non-ferrous metal mining industries have already rebounded, while coal mining and oil and gas extraction are the main drag. At the industry level, if we use the improvement in cumulative year-on-year revenue growth and profit margin since the second quarter as a measure, the fundamental improvement in the black metal mining, non-ferrous metal mining, cultural and artistic manufacturing, automobile manufacturing, and pharmaceutical manufacturing industries is relatively better.

The continuous improvement of domestic fundamentals is also reflected in the semi-annual reports of listed companies. As of now, the semi-annual reports of A-share listed companies have been fully disclosed. From the perspective of all A non-financial real estate, as of Q2 2025, the rolling 12-month return on equity has shown a marginal upward trend, and the year-on-year growth rate of operating cash flow and its proportion of revenue have continued to rebound, indicating that the operating conditions of enterprises under the listed company perspective have also seen marginal improvements. In addition, from the perspective of listed companies, the destocking of the industrial chain may also be nearing its end: the year-on-year revenue growth rate of all A non-financial real estate continues to recover, while the year-on-year growth rate of inventory has decreased to 0.8%, the lowest level since 2010; at the same time, the supply cycle has not yet begun to expand, with the ratio of capital expenditure to depreciation and amortization further declining to 1.2, also the lowest since 2010, while the ratio of construction projects to fixed assets continues to remain low. If demand recovers in the future, with relatively little pressure from new production capacity, inventory pressure may no longer be the core factor restricting price elasticity.

3. Overseas: Rate cuts boost global manufacturing recovery, breaking the singularity of AI investment

The inflation and core inflation readings for July under the PCE measure released this week in the United States were relatively mild and in line with expectations, while the University of Michigan's consumer confidence index for August showed a marginal decline. Currently, the upward pressure on domestic inflation in the United States is relatively weak, which further matures the conditions for the Federal Reserve to start cutting interest rates in September. From the current trading situation in the federal funds futures market, investors expect that the Federal Reserve will begin cutting interest rates in September, and that there will be more than two rate cuts within 2025, bringing the federal funds target rate down to around 3% by the end of 2026. The initiation of a rate-cutting cycle by the Federal Reserve is beneficial for the recovery of fixed asset investment and manufacturing activities in the United States.

The Bureau of Economic Analysis (BEA) is primarily responsible for the statistics related to fixed asset investment in the United States, but the frequency of publication is relatively low, with relevant fixed asset investment statistics only available when quarterly GDP is released; and the subdivisions are relatively few, categorized into residential investment, non-residential building investment, equipment investment, and intellectual property investment. However, it is possible to observe the situation of fixed asset investment in the United States more frequently and in more detail by finding economic indicators that are strongly correlated with the above-mentioned investment subdivisions.

From historical experience, the year-on-year growth rate of non-residential building investment under the GDP measure reported by the BEA has a correlation of nearly 70% with the year-on-year growth rate of non-residential building expenditures reported by the US Census Bureau In the past few months, the year-on-year growth rate of non-residential construction spending has begun to rebound. In terms of sub-sectors, construction investment activities related to utilities, energy, highways, communications, and water supply are relatively more active.

Historically, the correlation between equipment investment under GDP and the year-on-year growth rate of non-defense durable goods shipments is close to 90%. From the durable goods shipment statistics released this week, the shipment growth of primary metals, industrial machinery, and generators in the United States is relatively fast, indicating that current equipment investment activities in traditional manufacturing in the U.S. may be quite strong. Additionally, it is worth noting that the shipment growth rate of computer storage devices, which may be more closely related to AI investment, has shown marginal decline. Combined with the data from NVIDIA's second-quarter report indicating that data center revenue fell short of expectations and year-on-year growth declined, it appears that U.S. investments related to AI infrastructure may have begun to slow down.

4. Major Transition, Just Around the Corner

With the ongoing push against involution, the improvement in the operating conditions of domestic manufacturing enterprises is continuously being validated. At the same time, the conditions for overseas interest rate cuts are further maturing, which is conducive to the recovery of global manufacturing activities. Structurally, overseas traditional manufacturing equipment investment activities are relatively strong, while AI investment activities may have shown signs of weakening. From the perspective of global commodity supply and demand changes: it is transitioning from the past combination of China's commodity production expansion + overseas commodity demand contraction to China's production involution + overseas commodity demand expansion; from the perspective of monetary policy and China's production, it is shifting from global monetary policy tightening + China's production expansion to global monetary expansion + China's production slowdown. China's re-inflation is just around the corner, and our recommendations are:

First, physical assets that benefit from the improvement in operating conditions brought about by domestic involution, the recovery of overseas manufacturing activities, and accelerated investment: industrial metals (copper, aluminum, steel), raw materials (glass fiber, basic chemicals, steel), and capital goods (construction machinery, specialized machinery, mechanical components, heavy trucks);

Second, the long-term asset side of insurance will benefit from the bottoming and recovery of capital returns, followed by securities firms;

Third, after profit recovery, opportunities will also emerge in domestic demand-related fields. The repair of A-share heavyweight stocks has just begun, and we recommend paying attention to: food and beverages, power equipment, hotels, and catering.

Author of this article: Mu Yiling Team from Guojin Securities, Source: Yiling Strategy Research, Original Title: "Major Transition, Just Around the Corner | Guojin Strategy" Risk Warning and Disclaimer

The market has risks, and investment should be cautious. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at one's own risk