Industry momentum marks the starting line for market trends, but it certainly doesn't guarantee the finish. New analysis from the Essence Securities strategy team indicates that while A-share fundamentals are on a steady upswing—with non-financial earnings growth for all A-shares set to return to double digits in the first half of 2026 for the first time since 2021—converting this prosperity into actual market performance requires a more systematic framework. The new earnings cycle is being spearheaded by the technology and overseas expansion sectors.

Strategists Lin Rongxiong and Peng Jingtao have pioneered a three-factor pricing model for gauging industry prosperity, built on the relationship between capital expenditure growth, the second derivative of profit, and net margin. This model aims to answer the critical questions of when to buy, when to sell, and how high a rally can go. Their report indicates that sectors like semiconductors, communication equipment, consumer electronics, gaming, and batteries are currently in a "double-hit main upward" phase, with AI hardware and overseas expansion as the core common thread. Fundamental sell signals appear distant, and the signal to hold positions heavily during the main upward leg is clear.

From a macro perspective, the combined earnings share of technology and overseas expansion, excluding financials, is approaching 50%. This aligns with the historical A-share "30%-60%" earnings rule, where breakout moves in sectors like upstream cyclical stocks in 2005 and consumer+real estate in 2016 followed their earnings share surpassing the 50% threshold. This suggests that technology and overseas expansion are poised to lead a new earnings upcycle for A-shares.

Three-Factor Pricing Framework: Bridging the Gap Between Fundamentals and Market Performance

Essence Securities breaks down industry prosperity into three trackable indicators that form a closed loop of capacity and earnings cycles.

The first indicator is the difference between capital expenditure growth and profit growth, which signals buy points. This metric illustrates the pace difference between an industry's supply expansion and its earnings realization, typically leading profit turning points by two to four quarters. When capex growth persistently outpaces profit growth, it signals aggressive expansion and points to future supply pressure. Conversely, when capex growth lags profit growth or turns negative while profits are still recovering, it suggests capacity clearance is underway, laying the groundwork for the next prosperity upswing. In practice, a negative and narrowing differential confirms a buy signal from supply clearance, while a significantly positive and widening differential serves as a top warning.

The second indicator, the second derivative of profit, defines sell signals. It captures whether profit growth is accelerating or decelerating, acting as the direct driver of valuation expansion or contraction. A positive turn in this derivative is the earliest financial confirmation of a prosperity inflection, while a negative turn is the first alarm of a peak, typically leading net margin peaks by one to two quarters and stock price tops by about one quarter. Accelerating profit growth suggests holding through the main upward phase, whereas a peak followed by a decline, even with high absolute growth, triggers a sell signal.

The third indicator, net margin, determines the potential height of a market move. It is the most intuitive but easily misread metric, reflecting the cumulative result of an industry's pricing power and supply-demand dynamics. A new high in net margin implies valuation overextension and reduced upside, while a recovery from its bottom signals a potential "Davis Double Play" with opening upside. Historically, market peaks often occur in a "double high" phase, marked by a peaking second derivative with still-high growth rates and net margins at historical highs.

These three indicators are not isolated but form a feedback loop: high net margins attract capital expenditure, which widens the capex-profit differential, leading to increased future supply, pressuring margins, turning the profit second derivative negative, prompting companies to cut capex, which narrows the differential, leading to supply clearance, and eventually allowing margins to recover and the profit second derivative to turn positive again.

Eight Prosperity States: A Complete Trajectory from Clearance to Downturn

Combining all possible rise and fall permutations of the three factors yields eight prosperity states, charting a course through "clearance, repair, reversal, boom, peak, and primary decline."

The contraction group includes four sequential states: clearance bottoming (capex down, profit deceleration, margin decline), quality-led bottoming (capex down, profit deceleration, margin recovery), repair initiation with volume compensating for price (capex down, profit acceleration, margin decline), and the starting point for a double-hit main upward move (capex down, profit acceleration, margin recovery), which signals a heavy-buy opportunity.

The expansion group also has four states: prosperity peak (capex expansion, profit acceleration, new margin highs), revenue growth without profit growth and price wars (capex expansion, profit acceleration, margin decline), growth peak (capex expansion, profit deceleration, still-high margins) which signals a clear sell due to M-top risk, and the double-kill primary decline (inertial capex expansion, profit deceleration, margin decline) which warrants complete avoidance.

Historical Validation: Buy and Sell Signals Tested Across Industries

Essence Securities validates this framework with eight industry case studies.

The electronics sector (AI hardware) exemplifies a confirmed buy signal from the contraction group. In 2024, shrinking capex combined with a profit turnaround confirmed the buy signal. As the profit second derivative accelerated through 2025, stock prices have risen approximately 265% from their 2024 low. With profits still being released and margins rising, the double-hit logic appears incomplete.

The power equipment sector (new energy) confirms the "double sell signal" pattern of the expansion group. A growth peak in 2021 corresponded with a trading top, and a subsequent growth peak in 2022 marked the fundamental top, forming an M-top. After clearance in 2024 and a return to profit, the converging capex-profit growth differential in 2025 confirmed a new buy signal, leading to a cumulative rebound of 111%.

Communication equipment offers the most timely example. Since 2024, net profit growth has risen steadily (with a quarterly surge of 83% in Q2 2026) while capex contracted, forming a new buy signal. AI-driven demand has propelled stock prices up 732%. However, with net margins now at historical highs, the key to tracking the next sell signal is watching whether the profit second derivative peaks and turns down.

The liquor industry serves as a counterexample. Net profit growth peaked in 2021 and then trended downward, turning negative in 2025 without ever forming a buy signal combination. Stock prices have fallen 40% from their double top in Q2 2021 (which had gained 82%), validating the decision to avoid this sector. The photovoltaic equipment sector exemplifies "expansion overshoot." After high growth in 2022, an expansion race began, and by 2023, a significantly widening capex differential served as an oversupply warning. From 2024 to 2025, the sector saw losses deepen to -194%, and stock prices have dropped 42% from their peak. The sector remains in a fundamental quagmire, and intervention is unwise until clearance is complete.

Current A-Share Prosperity Landscape: The Double-Hit Main Upward Move as the Core Theme

Using its three-factor pricing model on A-share sub-sectors, Essence Securities classifies the current market into three tiers.

The first tier, "clearance bottoming," includes the property chain and some mid-stream sectors. Solar equipment losses widened to -13.6 billion yuan in H1 2026 (with a Q2 loss of 7.6 billion), indicating clearance is incomplete. Real estate development losses have narrowed by 17%, but sales haven't recovered. The liquor sector's Q2 decline deepened to -21%, and the aquaculture industry swung to a loss. A wait-and-see approach is advised until earnings inflection points are confirmed.

The second tier, "repair and climb," focuses on cyclical and pharmaceutical sectors with sufficient supply clearance. Coal mining saw H1 2026 growth turn positive at 28.9%, with a Q2 surge of 68%, confirming a bottoming and recovery on the right side. Refining, chemical fiber, and chemical raw materials saw Q2 growth accelerate to 76%, 151%, and 100%, respectively. After collection-based procurement clearance, medical devices are projected for 55% net profit growth in 2026, and innovative drugs are benefiting from overseas licensing deals. These all present clear phased entry signals.

The third tier, the "double-hit main upward move," represents the current market's core theme. The semiconductor sector's net profit growth accelerated from 167% in Q1 2026 to 236% in H1 2026, with a Q2 surge of 279%. Net margins have recovered significantly to 19.1%, up 11.8 percentage points from H1 2025. Communication equipment saw Q2 growth of 101%, and biological products showed the strongest reversal at 141%. AI hardware and overseas expansion form the core intersection, with clear signals to hold heavily during the main upward phase.

The report highlights that the current readings are structurally similar to the starts of the 2024 electronics and 2025 communication equipment rallies, but are starkly different from the "double high" sell signals seen in 2021 new energy and 2022 coal sectors. Fundamental sell signals are still far off. The key to profiting is not guessing the top, but tracking when the profit second derivative peaks and whether net margins become overextended at new highs.

A New Earnings Cycle: Tech and Overseas Expansion Reshaping A-Share Profitability

From a macro perspective, the A-share earnings structure is undergoing deep transformation. H1 2026 earnings growth for all A-shares and all A-shares excluding financials was 16.82% and 16.22%, respectively, a clear increase from Q1 2026 (7.27% and 12.32%). This marks the first return to double-digit growth for non-financial A-shares since 2021.

Structurally, approximately 25% of A-share revenue and 30% of profits now come from overseas. Excluding financials, the earnings share of technology and overseas expansion is approaching 50%. Following the historical "30%-60%" earnings rule, this approach to the critical threshold suggests a new upward earnings cycle is underway, similar to the "Five Golden Flowers" rally in 2005 and the "Nifty Fifty" rally in 2016.

The K-shaped economic trend persists, with significant capex increases in TMT and high-end manufacturing, contrasting sharply with old economy sectors like construction, building materials, steel, and food and beverage. This divergence is evident in their financials, as revenue and profit growth remain strong for the former while the latter continue to bottom out.

Regarding overseas expansion, the Tonghuashun Overseas Expansion 50 Index posted H1 2026 revenue growth of 20.53% and net profit growth of 29.99%, significantly outpacing the broader market. Its ROE has reached 18.63%, approaching 20% and far exceeding the A-share average, demonstrating superior earnings quality and momentum.

At the index level, H1 2026 earnings growth rankings are: STAR 50 (+202.97%) > ChiNext (+52.21%) > CSI 500 (+31.99%) > CSI 300 (+21.34%) > CSI 1000 (+14.20%). The ChiNext index leads with an ROE of 15.44%, marking it as the best representative index for the prosperity in tech hardware and mid-to-upstream overseas expansion sectors.

Essence Securities concludes that prosperity sets the direction, and the three factors set the pace. The direction is clear: technology and overseas expansion. These two forces are reshaping the A-share earnings landscape, driving China's macroeconomic transition from old to new growth drivers, and creating a new class of core assets within the A-share market that possess the qualities of industrial transformation and global competitiveness.