In China, the AI Bubble Has Already Burst as STAR50 Index Shed 40% in Under Four Months

In less than four months, China's STAR50 index, the mainland benchmark for artificial intelligence and semiconductor leaders, has lost 40 per cent of its value. Roughly US$480-billion in market value is gone. While tech shares elsewhere in the world wobble, China's AI trade has already broken.

The damage reaches well beyond the index. China's broad blue-chip index is down about 20 per cent from its June highs. The slide has halted a rally that ran for two years, since promises of economic stimulus sent shares soaring. It has also stalled Beijing's attempt to break the country's old boom-and-bust pattern and build what officials call a "slow bull" market that delivers steady returns. Beijing-based fund manager Dong Baozhen put it bluntly: the market turned into a "speculative crazy bull," and now the bubble is bursting.

The contrast with the United States is sharp. American AI stocks have led a 6 per cent drawdown in the Nasdaq from a record high set three weeks ago, which the report likens to a mere prick next to China's fall. There was no obvious trigger for the selling. Traders pointed to high prices, tax bills, and the risk that the U.S. or other countries might ban Chinese equipment from their data centres. Worries about AI demand and curbs on Chinese exports have weighed on sentiment too.

The pain is widely shared. According to Goldman Sachs, AI stocks make up 42 per cent of China's market capitalization and 57 per cent of turnover across mainland A-shares and Hong Kong H-shares, and small investors dominate that market. Robot-maker Unitree, whose listing in August was 8,000 times oversubscribed by retail buyers, has halved since it began trading. Chip maker CXMT has lost more than a quarter of its value in the past month. MetaX Integrated Circuits and Moore Threads Technology, which jumped 700 per cent and 400 per cent on their debuts last year, have both halved since July. Optical parts makers Zhongji Innolight and Eoptolink Technology are down about 60 per cent from their June and July highs, partly because Washington is moving toward barring them from supplying U.S. data centres.

Chen Wensheng, a small business owner and investor from Hainan in southern China, bought in because he saw official backing for names like Unitree, which counted state-backed funds among its investors. He and his friends are now sitting on losses. That frustration, with a Beijing-backed theme ending so badly, has pushed many investors toward defensive assets and is likely to slow equity fundraising by tech firms. Hong Hao, managing partner and chief investment officer at Lotus Asset Management in Hong Kong, said the rout will stop many companies trying to list.

Valuations are still steep. The STAR50 trades at around 100 times trailing earnings, down from a peak near 250, against about 30 for the Nasdaq 100, and some investors fear the selloff could worsen before it improves.

The episode cuts against authorities' stated aims. They have been cracking down on leverage and high-frequency trading to improve returns and dampen volatility, and state-backed investors sold into rallies to hold gains in check. The China Securities Regulatory Commission did not immediately reply to questions faxed by Reuters last week. Its chairman, Wu Qing, met market participants earlier this month to hear suggestions on improving capital markets, according to the regulator's website. Some in the industry say the boom damaged market structure. Leo Wang of Beijing-based Qianchuang Capital argued that overweighting tech in major indexes distorts capital behaviour, creating a severe bubble in some sectors and a serious drain on others.

Not everyone is bearish. Some see the selloff as neither surprising nor harmful to long-term reforms that have lifted returns, particularly income, in recent years. Asia funds have been sellers over the past three months but remain overweight China, according to HSBC research. Goldman Sachs put Innolight and CXMT among dozens of Chinese AI stocks on a revamped recommendation list earlier this month, and BNP Paribas Securities strategist William Bratton has called the market a buying opportunity for the careful. On the mainland, though, many are eyeing other sectors or waiting for lower valuations. Shanghai fund manager Wang Zhuo of Zhuozhu Investment Management expects chipmakers and AI suppliers to end up in a price war like other Chinese manufacturers. "All bubbles inevitably burst," he said.

What to watch: whether valuations fall far enough to draw buyers, and whether U.S. restrictions on Chinese equipment deepen.