Are generative AI bots bullish on China AI tech stocks?

Trading in Chinese tech, media and telecom (TMT) stocks in recent months has been in a frenzy. More specifically, artificial intelligence-related (AI) tech stocks, or the so-called ChatGPT-concept stocks, have experienced record surges in stock prices, far outpacing the broader non-AI related China market.

Excitement hit new heights in March. Speculative bets on Chinese AI-related tech stocks accounted for 40-50% of the total market turnover that month and crowded out most other sectors. The surge rode on the hopes that locally developed generative AI bots similar to OpenAI’s ChatGPT can revolutionize the sector and open up new paths to growth. But there are some signs that the rushed rotation into the AI theme could be distorting Chinese markets.

As investors flocked to AI-related names, we have stayed on the sidelines. The development of generative AI systems is in a nascent stage, and while potential applications across a wide range of industries seem limitless, runaway stock valuations of these Chinese companies are not supported by fundamentals.

In some ways, the rally was a product of an environment without a strong catalyst. Although Chinese economic growth in the first quarter was stronger than expected, a robust recovery is not a certainty. Investments linked to the reopening theme such as consumption and tourism related stocks have become very crowded, and expectations of positive surprises so far this year are low. The policy-sensitive property market was helped by government measures early in the year and is gradually recovering, yet it is unlikely to see more aggressive support.

In comes ChatGPT, with all the broader promises of generative AI; its ascent to game-changer status was fast and triggered a buying spree in related stocks. The furor is evidenced by Chinese AI tech stocks outperforming many of the US market leaders this year.

However, it is not hard to see that this phenomenon could pose wider risks. In fact, Chinese state media had cautioned investors against ignoring fundamentals and chasing the bullish sentiment and fast gains in ChatGPT-concept stocks.

Rather than jumping on the bandwagon, we turned to the US over the past few months to see what the market-leading technology companies are working on. We proactively increased our research efforts and resources dedicated to this area. We can then use this knowledge to identify proxies with higher elasticity in the China A-share market and invest in them.

Take ChatGPT as an example. ChatGPT is a generative AI chatbot developed by US company OpenAI and backed by Microsoft. It is built on a large language model (LLM) and trained on various machine learning techniques. We believe that ChatGPT provides a great entry point for investors to learn about the AI chatbot technology, digest the implications – economic or otherwise – and subsequently identify investment opportunities that may come with this technological development.

Even though the prototype of ChatGPT was launched last November, it only caught on and became very popular in China after February of this year. How do we know this? The demand for graphics processing units (GPUs), specialized electronic circuits that power AI chatbot models, was lackluster among Chinese technology companies until picking up significantly after February.

Having conducted deeper analysis of the high performing AI-related stocks in the China A-share market, we now have a better idea on how the AI chatbot race might evolve and which companies are likely become leading players. Companies focused on computational power and development of domestic GPU replacements appear well situated for the increase in hardware demand. Those that develop and integrate AI applications into areas such as ecommerce, online advertising/gaming and molecular development biology could also benefit greatly. In addition, we believe that long-only opportunities can also be found in the semiconductor sector.

The hyper market environment in past two months has echoes of 2014/15, the period where smartphone penetration in China rose sharply and the Web 2.0 era started to take center stage. To many investors, that time was remembered as a TMT market bubble with high profile fallen angels, brought down by heavy losses when the bubble burst.

But if Joseph Schumpeter’s theory on creative destruction is anything to go by, we could also view such failures positively because of the room for innovation they created. The process of innovation and technological change often leads to the destruction of existing industries, firms and jobs; however, several Chinese internet giants were birthed from that destruction during the TMT bubble.

The world has been struggling since then to find the next generation technology, to improve productivity and contain inflation – and to get excited about. While it may be premature to call generative AI the breakthrough technology we all have been waiting for, the technology itself and associated companies deserve more attention and closer examination. With this in mind, we have expanded our research list and screened for more names under this theme in both China and the US.

Many technological concepts that have come before generative AI chatbots have set off a buying frenzy: 5G, the fifth-generation technology standard for broadband cellular networks; augmented and virtual reality; and antiviral and antibacterial textiles for garments. In each case, when the excitement died down, stocks tied to those concepts corrected.

We expect the same with high-flying Chinese AI tech stocks. The overstretched valuations could unwind – and we are starting to see some signs of that – but a correction could bring about an attractive entry point for companies we have identified with potential to be market leading.

Whether generative AI chatbots are hype or not, we have been disciplined in keeping to our investment philosophy where we invest in alpha opportunities based on fundamentals. We believe investing in market-leading Chinese AI tech stocks could deliver attractive risk-adjusted returns and pay off in the long run.