China Equity Strategy-A multi-faceted look at DeepSeek's implications

ab12 February 2025Global ResearchChina Equity StrategyA multi-faceted look at DeepSeek's implicationsMore to go on the DeepSeek rally?The launch of DeepSeek's R1 model has put AI development in China back on investors' radar. Our tracking of AI related China-listed stocks (summarised in Figure 1) shows that since the start of the year the stocks are up 15% and have outperformed MSCI China by 9%. Fundamentally AI contributes a limited proportion of most companies' revenue and we think the fierce competition could limit earnings upside in the near term. That said, technology fuelled rallies typically saw share prices rise ahead of earnings and this year, with ample liquidity and lower interest rates, we see valuation re-rating opportunities ahead for AI-related names. Looking at the experiences during the 4G, 5G and Cloud computing eras, we saw outperformances of 50-100% for the related names, with these rallies typically lasting 1-2 years. As such, based on these prior experiences, it would seem that we are less than halfway through the rally (in particular for software names). For the broader market, we see some valuation upside potential from AI, with technology stocks contributing 12-20% of the index; historically A-shares have risen more from thematics than HK-listed names. Could DeepSeek fuel a broader rally in Chinese equities?Using the experiences during the 4G, 5G and Cloud Computing led rallies, we saw MSCI China rise 50% on average from trough to peak, with CSI300 rising more, at 72% on average. That said, we would caution against extrapolating these historical experiences as the market then rose mainly as a result of a broader macro recovery. During the initial part of the 4G rally in 2013-14, the equity market was broadly flat, while in 1H2023, AI-related names continued to perform well while the broader market sank as the re-opening benefits waned. Arguably the macro factors currently are less supportive than in the past, with the property market still under pressure and a trade war with the US looming. Looking at the sector composition of HK and A-shares, A-shares (CSI 300) are more heavily exposed to hardware and software names (at c.20%), while for HK (HSCEI), excluding the large internet names, the representation is relatively light at 12%. With HSCEI having outperformed CSI300 by 10% YTD, we believe A-shares are likely to be the better option for exposure to AI-related themes.Industry subsectors, what are our preferences?We have worked with UBS sector analysts to come up with a comprehensive list of AI-related names along various parts of the value chain in China and their international counterparts, which are summarised in Figure 1. This note also contains sector analyst assessment of the AI implications including hardware, software, internet, autos, industrials, financials, telecoms and healthcare. Fundamentally we believe infrastructure providers such as the IDC companies and the hardware manufacturers would see the ear