The AI industry is currently facing a contest between the pace of EPS upgrades and the speed of interest rate hikes.

1. The most friendly environment for the stock market is “Davis Double Play,” but most of the time it’s a dilemma—this has been true for 26 years in the tech industry as well.

On one hand, high oil prices and geopolitical tensions cause Fed rate cut expectations to fluctuate. Early in the year, the Fed’s rate cut expectations for the year approached 100%. During the peak of US-Iran conflict in mid-March, the probability of rate cuts dropped to nearly zero. As tensions eased later, expectations rebounded to 50%. However, due to negotiations stalling, the probability of rate cuts has been declining over the past month, until this week when the US rejected Iran’s 14 written proposals, bringing expectations back to zero. As shown by the yellow curve in the chart below, US Treasury yields follow a similar pattern.

On the other hand, the commercialization progress of the AI industry over 26 years is accelerating, with domestic and international tokens demand finding explosive points, driving upward revisions of profit forecasts and capital expenditure expectations for leading global companies.

2. It’s a contest between the speed of EPS upgrades and rising interest rates.

What happens when the numerator (fundamentals) and denominator (discount rate) diverge in valuation?

Historical cases between China and the US suggest: high growth can overcome an unfriendly interest rate environment, summarized as “rising with rate hikes.”

In our report “Beyond US-Iran Conflict and High Oil Prices, Which Industries Might Maintain Independent High Prosperity in the Future?”, we reviewed the impact of the 1999 Kosovo War, oil price hikes, US inflation, and Fed rate hikes on the US stock market and the tech bubble.

Other similar cases include:

(1) 1999 Tech: Kosovo War, high oil prices, US inflation, rate hike cycle, tech bubble

(2) 2023 AI: Post-Russian-Ukrainian conflict rate hikes, with intensive large model releases, driving the Nasdaq to outperform

(3) 2013 A-shares Mobile Internet: Liquidity crunch, TMT structural bull market

(4) 2016-17 Supply-side reforms: US-China liquidity resonance tightening, cyclical stock bull market

(5) 2021 New Energy: Rapid penetration, Fed rate hikes, domestic deleveraging, new energy industry bull market

When industry prosperity remains in a high-growth phase, and leading companies’ expectations for high growth this year and next are achievable, stock prices can still perform strongly—meaning high growth in earnings can beat liquidity tightening.

Several possible explanations are as follows—

1. Macroeconomic slowdown does not necessarily mean industry or leading company deceleration.

Fed rate hikes may suppress broad demand and negatively impact the economy, putting pressure on large-cap stocks and market indices. But once industry development trends are set in motion, macro shocks have limited impact—for example, in 2021, China’s real estate entered a downward cycle amid inflation pressures, yet the new energy sector entered a rapid penetration phase.

2. Macro liquidity tightening does not necessarily mean micro liquidity tightening.

The benchmark or risk-free rate increase corresponds to a broad liquidity contraction, but micro liquidity in the stock market is just one “water reservoir” within broad liquidity, and may not tighten in sync. For example, during the 1999 tech bubble, US mutual funds and individual investors still provided continuous incremental funds; similarly, in 2021, the development of public funds in A-shares improved micro liquidity.

3. The market tolerates high interest rates as long as leading companies’ performance expectations are met, and the current stock prices are not significantly affected by the rising discount rate.

The table below shows that most industry leaders have profit growth rates of 50% or even over 100%. Under such high growth, the FY1 PE dynamic valuation can generally be 30-50X, unaffected by the rising interest rate center.

Of course, if high growth cannot be sustained (e.g., in 2022’s new energy sector), market valuation tolerance will decrease accordingly.

4. Once we observe signs of marginal weakening in industry trend expectations—even if current profits still grow at a high rate—it’s prudent to take profits. This is perhaps the most important “discipline” in prosperity investing.

For example, in 2000’s tech industry and 2022’s new energy industry, when the growth expectation begins to weaken marginally (expected net profit growth drops to around 30%, or expected net profit growth halves significantly—see our previous report “Why Bother About Right or Wrong?”), then even a loose liquidity environment won’t help.

3. Historical case review: How industry cycles counteract expectations of liquidity tightening?

(a) US stock case: 1999 tech bubble, 2023 AI wave

1. Case one: 1999-2000 tech bubble—Y2K bug replacement cycle vs. Kosovo War and rate hikes

(1) Denominator side: Kosovo War, oil prices rise, triggering liquidity tightening.

In 1999, geopolitical conflict and oil prices were key factors ending the “blonde girl” narrative. After the Asian financial crisis, the global deflation cycle reversed, and commodity prices began to rebound. Additionally, in early 1999, OPEC and non-OPEC countries jointly cut production, and the Kosovo War broke out (March-June 1999). The war threatened Balkan and Mediterranean shipping, raising fears of supply disruptions, pushing oil prices from $10 to over $30 per barrel. Meanwhile, US CPI inflation also surged, prompting the Fed to resume rate hikes in June 1999, raising the federal funds rate from 4.75% to 6.5% by May 2000.

(2) Molecule side: “Y2K” (Y2K bug) drove high prosperity in tech in 98-99.

The Nasdaq’s continued strength during the rate hike cycle was supported by high expectations of Y2K-driven replacement demand. Under policies prioritizing system bug fixes (by OCC, FDA, DoD), governments and enterprises worldwide launched “panic buying” of old servers, mainframes, PCs, and OS software, igniting a replacement frenzy on the molecule side.

From 1997-1998, the fundamentals of tech giants had already declined; but the Y2K order surge expectation created a “brief boom” in tech leaders in 1998-1999.

(3) Market performance: Tech bubble burst

Dow Jones Industrial Average (DJIA) oscillated with rate hikes, but Nasdaq soared and peaked 9 months later. DJIA was pressured by high oil prices and rate hikes in Q3 1999, briefly rebounded in Q4, then peaked in January 2000. Nasdaq, however, continued its strong rally, rising 91% from June 1999 to March 2000, peaking 9 months after the rate hikes.

Independent industry prosperity can overcome high oil prices and rate hikes. Focus on the Nasdaq 100 index with actual profitability. Data shows that under the high prosperity expectations driven by Y2K, the EPS growth of Nasdaq 100 surged to 60% in 1999, with a trailing P/E ratio exceeding 90x; high valuation was not affected by war, oil prices, or rate hikes.

2. Case two: 2022-2023, AI industry explosion vs. post-Russian-Ukrainian conflict continued tightening

(1) Denominator side: Russia-Ukraine conflict disturbance, Fed tightening sharply

In 2022-2023, global markets remained under the shadow of the Russia-Ukraine conflict, with the Fed continuing to tighten and oil prices staying high. The Fed kept raising rates, maintaining policy rates at 5.25-5.5%. Long-term rates and commodity prices also pressured the market; at the Jackson Hole symposium in August 2023, Powell’s hawkish speech pushed US bond yields higher, while Brent crude stayed above $80. The dual constraints of high oil prices and high interest rates continued to suppress liquidity, creating a macro environment similar to the 1999 tech bubble.

(2) Molecule side: ChatGPT ignited the era of large AI models

From late 2022 to early 2024, the molecule side entered the “big model” era, with accelerated technological iteration. The release of ChatGPT in November 2022 sparked a global generative AI frenzy. In 2023, as the “big model year,” major tech giants launched models like GPT-4, Bard, Llama 2; Microsoft increased investments in OpenAI; Nvidia’s data center revenue exceeded expectations. In 2024, new models like Sora, Gemini 1.5 Pro, Claude 3 followed, expanding capabilities from text to multimodal.

2023 US Mega7 companies reported impressive earnings, with the AI cycle’s impact on fundamentals fully reflected in their financials. Nvidia, for example, saw net profit growth of 262% in mid-year and 581% for the full year, benefiting from massive demand for computing chips. Giants like Amazon also hit earnings inflection points; Google and Meta’s net profit growth rapidly reversed from large negative in 2022. The sustained demand for AI computing power and applications continues to drive profit recovery, providing solid fundamental support for tech sector rally.

(3) Market performance: Nasdaq rose and outperformed

In 2023, Nasdaq increased over 40%, unaffected by ongoing tightening. Despite persistent tight liquidity and rising benchmark rates, driven by the AI cycle, the market’s valuation was mainly based on the explosive industry trend. The Nasdaq, representing the tech industry, rose 43.4% in 2023, outperforming the Russell 2000, which lagged due to rate concerns.

(b) A-shares case: 2013 mobile internet, 2016-17 supply-side reforms, 2021 new energy

1. 2013 Mobile Internet wave: Structural bull amid “money shortage”

(1) Denominator side: Domestic “money shortage” + Fed QE tapering, extreme liquidity tightening

In 2013, “money shortage” and global liquidity tightened simultaneously, testing markets severely. The domestic financial market experienced a rare “money shortage,” as the central bank tightened liquidity in June to regulate shadow banking and interbank business. The SHIBOR soared to a record 13.44%, with some trades at 30% interest rates. Several banks faced actual liquidity breaches, and payment systems delayed. Meanwhile, the Fed signaled tapering of QE, causing 10-year US Treasury yields to jump over 100 basis points in three months, with global liquidity tightening.

(2) Molecule side: 4G base stations expansion, rapid growth of mobile internet and mobile gaming

The expansion of 4G base stations and mobile internet penetration surged, with clear industry chain validation. Starting in 2013, 4G infrastructure construction entered a new uptrend, with mobile internet market size growing over 80%. Mobile gaming, as a key application, saw explosive growth. The industry chain from base station deployment, network coverage to application adoption was clearly validated, supporting high industry prosperity and excess returns in the ChiNext, effectively offsetting liquidity tightening.

2013-2014, industry prosperity transmitted to listed companies, with TMT leaders showing high growth

Leading companies like Zhouchu Technology and Wangsu Technology saw continuous profit acceleration. Zhouchu’s net profit growth rose from 47.8% in 2012 to 86.7% in 2013, further to 145.3% in mid-2014; Wangsu’s mid-2014 net profit growth hit 246.7%, maintaining over 100% for the year. Other TMT giants like Digital China and Aofei Entertainment also posted high growth, confirming the high prosperity of the mobile internet industry in their financial reports.

(3) Market performance: 2013 ChiNext delivered significant excess returns, laying the groundwork for subsequent bull markets

Despite liquidity tightening, ChiNext outperformed significantly. During the “money shortage,” the 10-year government bond yield rose from 3.4% to over 4.6%. The ChiNext index, driven by industry prosperity, rose about 90% from May 2012 to May 2014, while the Shanghai Composite fell about 16%, resulting in over 100% excess return. The high prosperity of mobile internet effectively offset the valuation pressure from liquidity tightening.

2. 2016-2017, supply-side reforms: US-China resonance tightening, cyclical stocks rally

(1) Denominator side: Fed rate hikes + domestic tightening, liquidity contraction in both countries

US and China entered synchronized liquidity tightening cycles. The Fed began rate hikes at the end of 2015, raising the federal funds rate from 0.25% to about 1.5% by late 2017. Meanwhile, due to RMB depreciation and capital outflows, China’s liquidity tightened in late 2016, with 10-year Chinese bonds yields rising from 2.4% in October 2016 to around 4.0% at year-end. The PBOC also raised reverse repos and SLF rates in March 2017, tightening liquidity domestically and abroad.

(2) Molecule side: Implementation of supply-side reforms, cyclicals’ profit recovery

From “capacity reduction” to “environmental restrictions,” policies were implemented intensively. In early 2016, the State Council issued plans for steel and coal capacity cuts, aiming to reduce crude steel by 100-150 million tons and re-approve coal capacity over 276 working days. Mid-year, targets were reinforced: 45 million tons of steel and 250 million tons of coal cut. In 2017, focus shifted to environmental restrictions, with cities like Beijing-Tianjin-Hebei implementing air pollution control measures, restricting steel and aluminum production by over 30%. These policies tightened supply, leading to a bottoming and recovery of cyclicals.

Supply contraction drove quantity reduction and price increases, signaling cyclical bottoming

After policy implementation, steel, cement, and other cyclicals saw supply shrinkage, with prices rising from late 2015. In 2017, prices surged notably—rebar, cement, aluminum. ROE of these sectors also bottomed out and began to recover, with profits turning positive and rising steadily, supported by supply cuts.

2016-2017, supply-side reforms led to profit reversal in cyclicals

Leading cyclicals like Baosteel and China Shenhua saw profit growth rebound sharply. Baosteel’s profit growth in 2016 reached 849%, maintaining 64.9% in 2017. China Shenhua’s profit turned positive in 2016 at 40.7%, rising to 98.3% in 2017. Conch Cement’s profit grew 13.5% in 2016 and 85.9% in 2017. Fudan Carbon, benefiting from environmental restrictions and rising graphite electrode prices, posted a 5267% profit increase in 2017.

(3) Market performance: Cyclicals as the main industry theme

During the 2016-2017 tightening cycle, cyclicals outperformed the broader market significantly. The 10-year Treasury yield rose from 2.7% to about 4.0%, liquidity tightened. Cyclicals like coal, steel, nonferrous metals, and cement rallied strongly—up 49% from early 2016 to late 2017, outpacing the 20% rise of the Shanghai Composite, with excess returns of around 30%.

3. 2020-2021 New Energy wave: “Dual Carbon” goals vs. US bond yields rising

(1) Denominator side: Post-pandemic inflation, 10-year US bond yields climb steadily

From 2020-2021, liquidity shifted from ultra-loose to tightening expectations, with US bond yields rising in tandem with inflation. The Fed cut rates to zero and launched unlimited QE in 2020. In 2021, with vaccine rollout and Biden’s $1.9 trillion fiscal stimulus, US economic recovery expectations soared; crude oil rebounded, and CPI inflation surged above 5%. The 10-year US Treasury yield also rose persistently, reflecting market expectations of tightening.

(2) Molecule side: Dual carbon policies and technological advances boost renewable penetration

2020-2021, driven by dual carbon policies, technological progress, and cost reductions, the new energy vehicle (NEV) industry accelerated. Terminal demand exploded, with NEV sales and penetration rates increasing sharply. Solar exports grew rapidly, and supply chain prices rose significantly amid tight supply, with high industry prosperity offsetting liquidity tightening.

Leading companies in new energy reported high profits, with sustained earnings. CATL’s net profit growth in 2021 reached nearly 200%; SunPower and Tongwei doubled profits; Tianqi Materials’ growth exceeded 3000% in 2020, confirming the cycle’s realization.

Profit growth in new energy offsets US bond yield increases, with fundamentals leading pricing. Starting in late 2020, the 10-year US bond yield rose from lows, with global liquidity tightening. Yet, driven by profit growth, the new energy sector outperformed the Shanghai Composite, showing “fundamentals priced in, insensitive to rates.” When fundamentals are strong enough, liquidity tightening is no longer the core constraint for growth stocks.

4. Returning to the present: Industry itself often bursts bubbles, not interest rates

There’s no historical evidence that rising interest rates and liquidity contraction harm tech stocks or cause growth stocks to devalue. These notions are more like misconceptions that don’t stand up to scrutiny or empirical testing.

If stock gains are mainly driven by valuation expansion, then rate and liquidity tightening could be fatal.

However, when EPS expectations are being upgraded and dominate the trend in the global AI sector, each fluctuation in rates and liquidity may present a new opportunity to re-enter positions.

This article is sourced from: GF Strategy Liu Chenming / Zheng Kai

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