“What you think is a bull market is actually a bull market is bank.”

This amusing phrase crafted by stock investors perfectly encapsulates the recent trends of the A-shares in ChinaThe market sentiment has swiftly transitioned from an overwhelming need to embrace “AI” to a robust rally centered around “China Special Valuation.” Within this transformation, the banking sector has emerged as the star performer, leading the charge.

“China Special Valuation,” a valuation framework unique to China’s capital markets, focuses on major state-owned enterprises (SOEs) in critical sectors such as infrastructure, communications, military, and oilThis concept has become the hot topic in A-shares this year.

On May 8th, the “China Special Valuation” theme reignited market excitement, with financial stocks, particularly those from banks, showcasing impressive gains

By the day’s close, the China Banking Index was up by 4.18%.

China Bank experienced a rare surge that reached the daily limit, a feat not seen since July 2015. Agricultural Bank even hit a historical peak during trading, with all 42 bank stocks collectively logging gains.

Extending the timeline further, the past two months have seen banking stocks shine brightly under the support of the “China Special Valuation” contextTwelve banks reported price increases exceeding 20%, with Citic Bank soaring by an impressive 52.73% and China Bank climbing by 40.75%.

Three Catalysts Behind the Surge in Bank Stocks

Why have bank stocks surged?

According to Yu Zhanchang, a manager at Penghua Fund, the catalysts for this surge can primarily be traced to three key factors:

Firstly, there exists a significant valuation disparity between Chinese banks and their overseas counterparts

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Taking major state-owned banks as an example, the price-to-book (PB) ratio for Postal Savings Bank peaks at around 0.75, while other major banks hover between 0.5 and 0.6. In contrast, most foreign banks have a PB valuation exceeding 1. Given that many of these foreign banks also have substantial goodwill on their books, our domestic banks like China Bank appear undervalued, presenting ample room for correction.

Secondly, banks contribute to a win-win scenario by taking on certain social responsibilitiesMany investors tend to see banks as entities that should favor the real economy; thus, they expect banks to maintain low valuations“While we believe banks shoulder some social responsibilities, it does not mean they are endlessly subsidizing the real economy, as dictated by the characteristics of socialism with Chinese characteristicsMajor banks assisting in the long-term development of the real economy is a mutually beneficial relationship,” Yu stated.

Between 2020 and 2022, numerous enterprises faced severe external pressures

State-owned banks lent support to them through measures like deferring principal and interest paymentsAlthough banks might experience short-term profit losses, the long-term view suggests a vital role in helping thriving businesses navigate through challengesAnalyzing profit growth trends in recent years reveals that state-owned banks have rebounded with higher profit growth post-pandemic than before the pandemic, proving that taking social responsibilities doesn’t equate to diminished profitability.

Lastly, state-owned enterprise (SOE) reform is anticipated to enhance the valuation levels of banksOn February 23, 2023, the State-owned Assets Supervision and Administration Commission (SASAC) stated during a press conference that they aim to accelerate central SOEs' profit growth beyond the national GDP growth to achieve better results; they also stressed the need for robust performance metrics and improving executive efficiency.

Before 2021, most major state-owned banks, excluding Postal Savings Bank, had profit growth that trailed GDP growth

The ongoing SOE reforms are likely to rectify these issues and improve profit growth for banks, thereby restoring their valuations.

Is “China Special Valuation” the Next Big Thing After Artificial Intelligence?

The continuing strength in the banking sector is merely a reflection of the broader “China Special Valuation” phenomenon.

Previously, the TMT (Technology, Media, Telecom) sectors dominated the market narrative, which in turn obscured the “China Special Valuation” dynamicIn reality, the index for “China Special Valuation” has surged by 35.63% this yearAccording to statistics from Wind, there are 17 stocks in this category that have seen increases exceeding 50%.

“Although both ‘China Special Valuation’ and AI were trending popular concepts, the former has clearly begun to surpass the latter, particularly following the May Day holiday,” noted a report from Nanhua Futures

In the aftermath of the holiday, various “China Special Valuation” stocks reached new highs, with increased trading volumes indicating a vibrant market and fluid capital movements.

Nanhua Futures believes this outcome indicates one of two possibilities: either “China Special Valuation” experiences a peak, concluding the capital exchange game, or the market gradually acknowledges its main positioning, drawing in more funds.

Caixin Securities asserts that the recent dips in risk-free interest rates are a central reason behind the upsurge in the “China Special Valuation” sectorThey also predict that this trend will be more sustainable than artificial intelligence developments, citing four main reasons:

From a performance perspective, as earnings reports wrap up, the market will increasingly focus on earnings from May to September

As SOE reforms bear fruit, the overall performance of the “China Special Valuation” sector looks stronger compared to the AI sector, where earnings pressure is evident.

On the financial front, the prior excitement surrounding AI stocks led to a wave of capital reductions, thereby suppressing those market dynamicsConversely, the “China Special Valuation” stocks are overseen by SASAC, suggesting they did not experience waves of reductions and may even see increased dividends, strengthening the capital attraction.

In terms of market sentiment, the AI sector is already showing signs of considerable divergence, with electronics and computing sectors wavering for about a month while communications have similarly falteredMeanwhile, the media sector continues to set highsThe “China Special Valuation” focus is expanding, as banks and insurance sectors pick up the baton from construction stocks, serving as primary momentum for the market indices