Q2 A-shares Outlook: Opportunities and Allocation Strategies Amidst Volatility and Divergence

Ask AI · How does the Middle East conflict affect the second-quarter rebound logic of A-shares?

(This article’s author, Yang Delong, is Chief Economist at Qianhai Kaiyuan Fund)

1. Middle East conflict: Disrupting rhythm rather than changing the trend

In the first quarter, A-shares showed a pattern of oscillation and divergence overall. In early March, the Shanghai Composite Index broke below the high of 4,182 points and plunged sharply. The core driver of this significant adjustment was the escalation of the Middle East situation. The U.S. and Israel brazenly launched attacks on Iran, targeting Iran’s top spiritual leader Khamenei and senior generals for assassination, triggering Iran’s retaliation. Iran blocked the Strait of Hormuz, which is a vital passage for global oil transportation, controlling 20% of the world’s oil and gas shipments. This caused international oil prices to soar from $73 per barrel before the war to $120 per barrel, raising concerns among investors that the global economy might slip into stagflation. Meanwhile, the Federal Reserve, to counter potential inflation, had to delay its rate cut pace, possibly even halting rate cuts for the year, which also led to a significant decline in the A-share market.

Compared to the market adjustment in March 2025, the main driving factors behind this decline are quite different. Back then, the sharp drop was due to Trump’s announcement of tariffs on the entire world, initiating a trade war. After the plunge, institutional funds and national team capital entered the market, leading to a strong rebound. Technically, the Shanghai Index had already broken below 4,000 points and fallen through the 60-day moving average dividing bull and bear markets. Whether this Middle East conflict will end the slow and long bull market of A-shares is a question many investors are asking. My clear view is that the core logic of this slow and long bull market has not fundamentally changed. The conflict disrupted the market’s rhythm but did not alter the trend. The market’s decline is an opportunity to position in quality stocks or funds. As policy support gradually emerges, the market may oscillate repeatedly and gradually reach a true bottom.

2. Historical comparison: rebound logic after adjustments

From April to June last year, after a sharp decline, the market experienced a V-shaped recovery, driven by policy and fundamentals resonating to push the index higher. In the second quarter of this year, the A-share market may replicate the recovery pattern seen in the same period in 2025, with a substantial rebound, possibly even forming an independent rally and reaching new highs for the year. This is because, in the second quarter, with the disclosure of annual reports, some sectors and stocks with better-than-expected performance may see valuation repairs. Additionally, Trump faces significant anti-war pressure domestically and may seek a dignified way to exit the war. If the Middle East situation eases and the Strait of Hormuz resumes normal navigation, the A-share market could also see a large rally.

Currently, external markets continue to oscillate, Fed rate cut expectations are gradually diminishing, and Middle East geopolitical conflicts persist and intensify. These external disturbances have altered the rhythm of A-shares but have not changed the long-term trend. For the second quarter, the biggest marginal influence remains the timing of the war’s end. It is expected that by April, the three parties involved may resolve major differences through negotiations, achieve a ceasefire, or even end the war in April, which could significantly impact the market and potentially trigger a bottoming rebound.

At the end of the first quarter, financing balance decreased, and funds temporarily exited the market. However, institutions still maintained high positions and plan to buy on dips in the second quarter, focusing on technology stocks and heavy-asset, low-volatility HALO assets (such as AI infrastructure). If the market experiences unexpected volatility or if stable operations like the Central Huijin Investment buying ETFs, insurance funds, and mutual funds increase holdings again, attracting off-market capital, then incremental funds mainly depend on institutional accumulation and long-term capital inflows. The key trigger remains the significant easing and potential end of the Middle East war.

3. Investment main lines: Price increase concept + AI technology dual drivers

The market generally expects that in the second quarter, A-shares will shift from liquidity-driven to profit-driven growth. As preliminary annual report results are announced and the intensive disclosure period for Q1 earnings begins in late April, this transition may gradually complete. Sectors and stocks with strong performance are likely to attract capital inflows, while some companies that fail to meet expectations may see significant adjustments. In Q1, the outperforming sectors mainly included technology, such as high-growth chips, semiconductors, computing power algorithms, and power grid equipment.

The main theme of this rally is the dual drive of price increase concepts and AI big tech. The core logic of these two themes is expected to gradually materialize in Q2. The price increase concept mainly focuses on lithium batteries, chemicals, and new productive forces-related sectors. The AI technology theme’s sub-industries may perform even more prominently, becoming the core investment theme in Q2, such as previously strong-performing but recently corrected sectors like chips, semiconductors, humanoid robots, and computing algorithms. Investors can seize opportunities by investing in leading stocks or quality thematic funds.

During the adjustment period in March 2025, small-cap stocks significantly outperformed large caps. In Q1 2026, AI growth tracks led the rally, while defensive sectors like banking and coal lagged. The style of the A-share market in Q2 may shift somewhat, with rotations between large and small caps and technology stocks. Recently, the frequent performance of traditional blue-chip stocks also reflects a style shift. In asset allocation, investors should maintain a balanced approach, with about half in growth stocks and half in value stocks, to ensure both offensive and defensive capabilities.

In Q2 2026, the key risk to watch is whether the Middle East war could spiral out of control. Another risk is the potential for companies to report earnings misses. Recently, some ST stocks have experienced large adjustments; for companies with deteriorating fundamentals and earnings risks, investors should remain cautious and avoid poor-performing stocks, especially ST stocks. ST stocks typically have losses for two consecutive years; if their performance does not improve later, they risk delisting. Given the overall economic slowdown, ST stocks are unlikely to see a remarkable turnaround, as many are driven by hype and concepts rather than fundamentals.

Q2 is likely to be a volatile market. Investors should keep their positions at around 50-60%, with a balanced allocation—half in leading tech stocks and half in high-quality blue chips. This approach offers a balanced offense and defense. In the current uncertain international situation, adhering to value investing principles is crucial.

This article reflects only the author’s views and does not constitute investment advice.

(This article is from First Financial)