China's A-share market saw the conclusion of the 2026 interim earnings season, with the pace of revenue and net profit growth for all A-shares (excluding financials and PetroChina) continuing to accelerate in the second quarter, aligning with market expectations. On an annualized basis, the sectors experiencing the most significant quarter-over-quarter expansion in revenue growth were cyclical industries, stable sectors, and TMT. Meanwhile, the same quarter net profit growth widened for cyclical industries, TMT, and financials, whereas midstream manufacturing saw a narrowing in both revenue and net profit growth.
Looking ahead to the third quarter of 2026, factors such as a pullback in the Producer Price Index (PPI), mounting revenue growth pressures, and escalating cost pressures are likely to weigh on performance, with a probable slowdown in growth for cyclical and manufacturing sectors. With the second-quarter earnings season now in the rearview mirror, several key trends emerge across both the aggregate and sector-specific levels. First, the uptrend in Q2 revenue and net profit growth, alongside improving profitability, has come in as expected, supported by a higher PPI midpoint and contained cost pressures. Second, from a sector perspective, cyclical, stable, and TMT industries recorded the broadest quarter-over-quarter revenue expansion, while midstream manufacturing saw a slight contraction and consumption a notable deceleration. On the net profit front, cyclical, TMT, and financials saw the widest gains, midstream manufacturing narrowed, and consumption saw a deepening contraction.
Supply-side pressures in upstream cyclical and midstream manufacturing continue to ease, with the bottom for fixed asset formation growth in midstream manufacturing appearing in the second quarter at 8%, underpinning pricing power and profitability resilience. Upstream cyclical fixed asset formation growth is expected to decelerate through the first quarter of 2027. While Q2 is likely to mark a short-term cyclical peak in earnings growth, with Q3 expected to underperform, the medium-term trajectory remains constructive, as supply growth across cyclical and manufacturing sectors is expected to stay at cyclical lows through 2027, supporting stable-to-improving profitability and preventing a sustained downturn in earnings momentum.
Our medium- and short-term market outlook remains unchanged. Following a second market bottom, we anticipate a rebound that could persist into late September. We expect the market to rally as policy measures aimed at steady and long-term development take effect. The most pronounced rally is likely to materialize after optimistic expectations across long, medium, and short-term horizons converge. The AI supply chain, however, requires a higher threshold of industrial catalysts to resume its upward trajectory, likely demanding more time. This suggests September may not see new highs, with another corrective phase likely ahead. The technological sector's pullback and consolidation could extend for a quarter.
Both macroeconomic and industrial landscapes present a challenge of near-term dynamics failing to extrapolate into long-term forecasts. Elevated US Treasury yields are inconsistent with sustainable long-term US fiscal policy and manageable corporate credit risk. Similarly, widespread inflationary pressures across AI computing hardware components clash with the premise of expanding AI applications in the future. While short-term positive catalysts in the AI supply chain support a technical rebound, lingering concerns about medium-term industry volatility continue to cap valuation expansion.
We reiterate our outlook for a rebound through September, focusing on opportunities that can most effectively recover recent losses during this oversold bounce. Within the AI supply chain, we favor non-institutionally heavy positions, specifically the domestic computing power chain and small-cap AI stocks, which could serve as short-term catalysts within a medium-term strategy. Sectors with emerging industrial momentum, such as overseas AI computing chains including NVIDIA-linked, memory, and PCB providers, also offer short-term upside potential. Post-September, we expect the technology sector's correction to persist, with non-tech sectors likely to outperform for an extended period, while high-dividend assets are poised to deliver positive absolute returns longer.
In non-tech growth areas, innovative drugs and CXO sectors have demonstrated their ability to attract a virtuous cycle of capital flow. A rapidly forming consensus around precious metals also offers similar potential. Additionally, we highlight opportunities in industrial metals and basic chemicals. Our strategy for high-dividend assets remains anchored on the divergence between CSI 800 index weights and Q2 2026 public fund holdings, focusing on banks, non-bank financials, food and beverage, and utilities.
Risk factors to monitor include an unexpectedly severe overseas economic downturn and a domestic economic recovery falling short of expectations.