Hong Hao says 30% AI correction is mid-cycle, rotation not over

The rotation from AI stocks into traditional sectors is far from complete, with the 30% correction in Chinese AI names representing only a mid-cycle consolidation, Hong Hao said.

"The adjustment is clearly a mid-cycle consolidation," Hong Hao, chief economist at GROW Investment Group, said in a Swiss Julius Baer monthly dialogue. "While some stocks have fallen sharply, the overall sector adjustment is far from complete when observed through the Korea KOSPI index."

Capital has rotated from overheated AI and semiconductor names into previously neglected sectors over recent weeks, with internet giants such as Tencent Holdings (0700.HK), Alibaba Group (9988.HK) and Meituan (3690.HK) posting gains of 10% to 30%. The CSI Value Index has begun outperforming the CSI Growth Index, a trend Hong expects to persist. The Hang Seng Index closed nearly flat at 25,132 on July 21, while the Hang Seng Tech Index rose 1.32% to 4,814, with turnover reaching HK$289.9 billion.

The rotation matters because it reflects a reassessment of China's economic breadth. "If AI development is booming and the economy is growing strongly, how could old economy sectors not benefit?" Hong said. "It should be a broad rally, not just capital chasing a few sectors." The divergence carries implications for portfolio positioning as investors weigh whether the AI trade has peaked or is merely pausing.

The July 21 session illustrated the market's conflicting signals. While Hong argued the rotation to value has further to go, Hong Kong's semiconductor stocks surged more than 11% that day, with Hua Hong Semiconductor jumping nearly 18% and SMIC gaining more than 8%. AI large model concept stocks also staged a powerful rebound, with Zhipu skyrocketing nearly 37% and MINIMAX surging over 15%. The contrasting moves — a flat HSI masking furious tech buying — highlight the volatility that has characterized the market since AI stocks peaked. The Hang Seng Index briefly breached the 25,000 level during the session before recovering, with an intraday range of about 260 points.

Hong attributed the turbulence to a fundamental disconnect between price and fundamentals. "These stocks have no major issues with their fundamentals, but their share prices have already priced in and over-discounted the fundamentals, leading to a disconnect," he said. "This easily triggers at least a major technical correction, which is hard to resolve within a week or two."

Fed Tightening Poses Downside Risk to Risk Assets

Beyond sector rotation, Hong flagged the Federal Reserve's policy trajectory as a key risk. The new Fed chair's hawkish rhetoric has pushed markets to price in a higher probability of rate hikes, though the path remains uncertain. "Whether it's a rate hike or balance sheet reduction, both will exert downward pressure on risk assets," Hong said.

He questioned whether the Fed can effectively shrink its balance sheet, noting that the overnight reverse repo facility — a key source of liquidity — has already fallen back to levels last seen during the 2023 Silicon Valley Bank crisis. "If balance sheet reduction threatens liquidity, the market could collapse," he said. Despite June inflation coming in better than expected due to a sharp drop in fuel prices, Hong argued that the lagged effects of past monetary expansion mean inflation and inflation expectations are likely to rise in coming months.

RMB Appreciation Trend Intact but Pace to Slow

On the currency front, Hong said the renminbi's long-term appreciation trend is likely not over, but the pace needs to moderate after this year's rapid gains. The yuan has strengthened to around 6.77 against the dollar, driven by China's strong export performance — June exports rose 27% year over year.

"The renminbi's nominal interest rate and real exchange rate are diverging, and the real exchange rate is one of the most undervalued currencies globally," Hong said. "This is the foundation for long-term appreciation." However, with the dollar index likely to find support around 100 and potentially strengthen on rate hike expectations or safe-haven flows, the yuan's near-term advance may stall.

Hong expects China's full-year gross domestic product growth to approach the 5% target, with policy remaining "stability first" — focused on filling structural gaps and boosting consumption in the second half. Large-scale stimulus is unlikely unless the Iran conflict deteriorates unexpectedly, he said.

This article is for informational purposes only and does not constitute investment advice.