In July 2025, China launched a sweeping “anti-involution” campaign (反内卷) to combat destructive price wars and industry-wide excess capacity. Unlike the 2015 supply-side reforms—which targeted SOE-dominated upstream sectors like coal and steel with direct administrative cuts and shantytown-driven demand stimulus—this round adopts a more market-based, regulatory-heavy approach. It spans both old-economy sectors (coal, steel, cement) and new-economy growth drivers (solar, EVs, batteries, platform companies), with the overarching goal of restoring pricing power and corporate profitability without relying on aggressive stimulus.
Among the worst-hit is the solar sector, where capacity utilization has plunged to 40–50%, over 90% of companies are loss-making, and Q2 prices fell by over 20% year-on-year. Coal sector profits declined 58% YoY, while industrial earnings overall have contracted for six consecutive quarters. In the EV and battery space, years of price undercutting eroded margins and delayed meaningful R&D. Regulators have since called on automakers to end aggressive discounting and to normalize supplier payments. Platform companies, too, are facing pressure to curb predatory pricing and improve labor standards—benefiting larger, more compliant players.
With this campaign underway, we are unlikely to see the return of price slashing as a growth tactic—an important shift that could relieve margin pressure and reallocate capital toward innovation. Meanwhile, policy signals have already lifted sentiment: futures prices of coal, lithium, and polysilicon surged in July. If involution measures are implemented effectively and domestic demand gradually recovers, we believe China/Hong Kong equities could undergo a valuation re-rating. However, the outlook hinges on credible capacity reduction, curbing local protectionism, and stronger support for household consumption. Under base-case assumptions, PPI is expected to remain negative into 2026.
The rally in Hong Kong and Chinese equities this year has been fueled by a combination of factors: the rise of AI themes (notably the emergence of DeepSeek), supportive government policies, a revival in IPO activity, attractive valuations, low foreign investor positioning, and a weaker U.S. dollar, which spurred global capital flows from the U.S. into other markets—benefiting China in particular. As of July 2025, the Hang Seng Index (HSI) delivered a strong 23% return, while the CSI 300 underperformed with a 3% gain. The outperformance of H-shares over A-shares was driven by robust liquidity tailwinds, including global fund inflows and strong southbound demand—1H2025 alone accounted for 91% of 2024’s full-year total. A-shares lagged primarily due to persistent capital controls. As of end 31 July 2025, the Hang Seng Index (HSI) is trading at 10.9x P/E, 0.5 standard deviation above its 10-year mean, while the CSI300 is trading at 14.0x P/E, 1.1 standard deviation above its 10-year mean. Given these valuation levels, the market is no longer considered cheap and it would be unsurprising to see investors locking in gains and moving to the sidelines, awaiting more decisive policy actions from the government before re-entering.
Exhibit 1: HSI 10-year valuation chart
Source: Bloomberg, 31 July 2025
Exhibit 2: CSI300 10-year valuation chart
Source: Bloomberg, 31 July 2025
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