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Navigating the Chinese AI Market: A Reality Check Amid Skyrocketing Valuations

The unprecedented growth in China’s artificial intelligence (AI) stocks shows signs of fatigue, leading some to question whether the market has overestimated its potential. High-profile companies such as SenseTime Group Inc. and Baidu Inc. have experienced a slowdown in share performance as investors anticipate first-quarter results. A related index has even recorded its worst weekly drop since November.

The Growing Skepticism and Market Caution

Market skepticism has been intensified by state-media warnings about potential bubbles, emphasizing the increasing caution in China’s technology sector. 

This week, the industry received another setback as some of the world’s most prominent investors signaled a further withdrawal. As a result, market participants are beginning to question whether the earnings potential of AI firms justifies their elevated valuations, following a months-long rally that included software developers, chipmakers, and healthcare providers.

Christina Woon, investment director at abrdn, notes, “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.”

Reality Check for AI Companies

Recent developments indicate that reality is beginning to set in after extraordinary gains, with companies such as Cambricon Technologies Corp. and CloudWalk Technology Co. surging by 257% and 174%, respectively, this year. 

A FactSet gauge tracking the Chinese AI sector has declined by 4.3% in the past five days, marking its worst weekly performance since November.

SenseTime’s shares fell by over 12% in Hong Kong this week after introducing its Chinese counterpart to ChatGPT. Similarly, Kunlun Tech Co. warned that its AI model requires significant investment and might only yield returns much later.

The Case of Baidu’s “Ernie Bot”

Baidu has almost entirely wiped out its gains since the mid-March introduction of its “Ernie Bot” with a pre-recorded demonstration. Thomas Chong, an analyst at Jefferies, reduced his margin forecast for the company, noting that higher investment costs could persist for several years.

Despite recent weakness, the CSI 300 Information Technology Index has risen 29% this year, outperforming the MSCI China gauge, which has gained around 4%. The IT index is trading at approximately 27 times forward earnings, nearing its highest level in two years.

The Long-Term Outlook for AI Stocks

Prashant Bhayani, chief investment officer for Asia at BNP Paribas Wealth Management, believes that corrections are normal at this stage, but warns that investors entering the market last could face short-term losses. He adds, “These themes will take time to play out, and we are early in the process.”

AI stocks have generated considerable excitement, accounting for approximately 8% of total A-share turnover in the first week of April, with the semiconductor index contributing 12%, according to JPMorgan Chase & Co.

A JPMorgan strategist, Wendy Liu attributes the AI stock buying frenzy to onshore mutual funds pressured to deliver rapid returns. She believes the rally can be sustained if AI providers can fulfill their promises.