China AI Stocks Frenzy Loses Steam as Earnings Doubts Creep In

(Bloomberg) — The rapid-fire gains in China’s artificial intelligence stocks are starting to show signs of wear, prompting some to ask: did the market get ahead of itself?

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From SenseTime Group Inc. to Baidu Inc., shares tracking the ChatGPT frenzy have lost momentum as investors await first-quarter results, with a related index recording its worst weekly drop since November. Money managers are watching for any fresh warnings from firms about their limited capability on the AI front as they weigh Beijing’s plans for greater oversight of the industry.

The growing skepticism — exacerbated by state-media’s calls about signs of a bubble — highlights broader caution toward China’s technology sector, which was dealt a new blow this week after some of the world’s biggest investors signaled a further retreat. Following a months-long rally that swept up software developers, chipmakers and even health-care providers, market players are starting to question whether the earnings potential of AI firms justify their rich valuations.

“It’s possible there are more legs to the run, but without fundamentals backing the extent of the run, the risk of correction is something we need to be alive to,” said Christina Woon, investment director at abrdn. “It is important to exercise caution and be selective because sentiment will be volatile on the road to commercialization, and as expectations on both timeline and potential are missed or beat.”

There are signs that reality may be setting in after a bout of dizzy gains which saw Cambricon Technologies Corp. surge 257% this year and CloudWalk Technology Co. jump 174%. A FactSet gauge tracking the Chinese AI sector declined 4.3% in the past five days to cap its worst weekly performance since November.

In Hong Kong, SenseTime slumped over 12% this week after unveiling its Chinese challenger to ChatGPT. Similarly, Kunlun Tech Co. has warned that its AI model needs a lot of investment and may only yield returns much later.

Meanwhile, Baidu has erased almost all its gains since introducing its “Ernie Bot” with a pre-recorded demonstration in mid-March. Jefferies analyst Thomas Chong on Thursday slashed his margin forecast for the company, saying that the higher investment costs may run for several years.

But even with the recent weakness, the CSI 300 Information Technology Index is still up 29% this year, outperforming the MSCI China gauge which has gained about 4%. The IT gauge is trading at about 27 times forward earnings, near the highest in two years.

“Corrections are normal at this point and the proverbial last in could face potential losses in the face of any drop short-term in shares,” said Prashant Bhayani, chief investment officer for Asia at BNP Paribas Wealth Management. “These themes will take time to play out and we are early in the process.”

The excitement surrounding AI stocks was so high that an index tracking the shares accounted for about 8% of total A-share turnover in the first week of April, while the semiconductor index made up 12%, according to JPMorgan Chase & Co.

Wendy Liu, a JPMorgan strategist, said the AI stock buying frenzy has also been driven by onshore mutual funds pressured to deliver quick returns. Back in 2021, the trade of the day was renewables. In 2022, it was energy. Recently, it’s been AI-led tech plays, she said.

The rally can be sustained, though, provided AI providers are able to deliver on their promises.

“This is a trade you want to be in for the long term, so pullbacks are not worrying to me, at least not for a few more months,” said Wu Yuefeng, fund manager at Wenzhou Jia Yue Investment Management Co. “But in six months’ time, investors will grow increasingly less tolerant if AI doesn’t start contributing to the bottom line.”

–With assistance from April Ma, Lin Zhu and John Cheng.