Macro Themes and Factor Performance
In recent quarters, we’ve spent a good deal of time highlighting China’s “two-speed” economy, with firms at the intersection of exports and high-tech manufacturing enjoying robust growth and strong investor sentiment, while companies serving China’s domestic consumers languished. That trend finally gave way over the last few months, as bulls supporting what they saw as a “boom” in AI hardware stocks began to fret that perhaps the bears were right all along and it was really more of a “bubble”. Earnings announcements have added to investors’ anxiety, as intense competition—the “involution” against which policymakers have warned—dented profitability and led to some high-profile misses. Since hitting a 52-week high in late June, the CSI 300 Index had fallen over 20% by mid-October: a big enough decline to put mainland stocks in a bear market. The CSI 300 Information Technology Index shows the degree to which tech has driven that sell-off, having slumped by about 40% since peaking at the end of June.
Fortunately, it was not all bad news in Q3: Despite the broad market’s struggles, factor-level results did not disappoint, with each of the major factor categories we track posting positive results. Indeed, factor premia over the last three months were almost the mirror image of those we reported for Q2, with Growth and Quality delivering weakly positive results, while defensive factors like Value and Low Risk strongly outperformed—in other words, pretty much exactly what one would expect, knowing the index was slumping and that tech stocks were driving much of the weakness. Small caps also staged a major reversal in the third quarter, representing the strongest factor-level performance driver and reflecting two potential nuances associated with competitive pressures facing Chinese tech stocks: first, that the greatest involution is hitting mega-cap industry behemoths; and second, that small-and mid-cap manufacturers of high-tech hardware exports have continued to enjoy robust demand as the AI supply trade keeps going strong, in spite of increasing doubt over the longer-term sustainability of all that infrastructure capex.
Comments on Index Performance in Q3
Given the sharp reversal in onshore investor sentiment since late-June—reflected in plummeting stock market turnover and margin balances—it is little surprise the CSI 300 Index declined, finishing down 11.7% (CNY) over the three months ending September 30st, 2026, as shown below. Risks likewise continued to loom over US stocks, including continued hostilities in the Middle East, sticky inflation and a hawkish Fed, as well as surging bond yields. Investors seemingly overcame that litany of concerns by simply focusing on a perceived bright spot, the ongoing boom in AI hardware, pushing the S&P 500 Index to a 1.1% (CNY) gain for the quarter. Stocks in the broader set of developed markets, represented by MSCI World Index, posted a similar return, up 0.8% (CNY) in Q3. Within emerging markets, investors weighed fears over a US-Iran stalemate, persistent inflation, and future Fed hikes against an astonishing rally in East Asian AI stocks, ultimately electing to take profits, leading to a modest decline in the MSCI EM Index of 0.4% (CNY) over the last three months.
The third quarter’s reversal in sentiment and rotation from high-tech growth to defensive names was reflected in performance of the Bedrock and New Economy strategies over the last three months, with the CSI Caixin Rayliant Bedrock Economy Index (tracked by Premia’s 2803 HK/9803 HK ETF) posting a 10.5% (CNY) increase, even as the CSI Caixin Rayliant New Economic Engine Index (tracked by Premia’s 3173 HK/9173 HK ETF) fell by 13.9% (CNY) for the quarter. The Bedrock strategy’s tilts toward Value and Low Risk stocks—both of which hurt performance in the second quarter—were the biggest factor-level contributors in Q3. While both strategies benefited from exposure to small-cap stocks and the Growth factor was modestly positive for the quarter, the New Economy portfolio was unable to escape the sector-level drag stemming from its very intentional structural tilt toward technology-themed areas of the economy suffering most amidst a pullback in the growth theme. Along those lines, the biggest sector-level detractors for the New Economy portfolio were an underweight to Financials and weak stock selections among Industrial shares. We should note that solid factor performance actually added to relative performance for the New Economy strategy within the IT sector, where a tilt toward high-quality growth apparently helped stem losses for the quarter. From a sector standpoint, the Bedrock portfolio benefited from its underweight to IT and overweight to Financials; stock picks within the Industrial sector also added considerably to excess returns in Q3.
In fact, as we process the mainland stock market’s outsized swings in sentiment and returns over the last few quarters, it is worth spending a little more time thinking about the factor dynamics just discussed: those tilts in the portfolio that boosted the Bedrock strategy to a big gain in Q3, even as the broad market sold off, and which provided support to the New Economy strategy, preventing a tech-led rout from pushing this growth-oriented portfolio into an even deeper drawdown. The philosophy behind these factor bets—and the basis for our belief in their long-term efficacy—is that a systematic approach to portfolio construction can intelligently exploit biased retail investors’ mistakes. Many of those behavioral errors ultimately come down to some form of mis-reaction when it comes to information affecting markets and the individual stocks that make them up. One of the compelling things about China’s market, in our view, is how large a chunk of trading is being done by behaviorally biased retail traders. But the very thing that makes the alpha opportunity so promising in mainland stocks also likely contributes to the exceptional volatility we sometimes see in the A shares market.
As such, we are not discouraged by the slide in mainland stocks over the last quarter. On the contrary, for investors looking for bargains amidst the sell-off, we believe it likely represents a good entry point after the valuation reset. Nor are we worried about the fundamental concerns that precipitated onshore investors’ current bout of bearishness. While China’s domestic economy is clearly still weaker than investors would hope and Beijing has not come in with the stimulus “bazooka” some desire, we believe policymakers are on the right track, and that a resolute commitment to high-quality growth and sustained policies to promote China’s technology self-sufficiency put investors in a much better place to capitalize on longer-term transformational opportunities in China’s market. Though the swings in onshore sentiment can be frustrating, we believe investors will be well-served who look past the short-run volatility with holding power for opportunities in terms of both the beta and alpha in China A shares.
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Dr. Phillip Wool is the Global Head of Research of Rayliant Global Advisors. Phillip conducts research in support of Rayliant’s products, with a focus on quantitative approaches to asset allocation and return predictability within asset classes, as well as the design of equity strategies tailored to emerging markets, including Chinese A shares. Prior to joining Rayliant, Phillip was an assistant professor of Finance at the State University of New York in Buffalo, where he pursued research on quantitative trading strategies and investor behaviour, and taught investment management. Before that, he worked as a research analyst covering alternative investments for Hammond Associates, an institutional fund consultant. Phillip received a BA in economics and a BSBA in finance and accounting from Washington University in St. Louis, and earned his Ph.D. in finance from UCLA, where his research focused on the portfolio holdings and trading activity of mutual fund managers and activist investors. Premia China New Economy ETF and Premia China Bedrock Economy ETF track the CSI Caixin Rayliant New Economic Engine Index and CSI Caixin Rayliant Bedrock Economy Index respectively.
