China's AI Bubble Has Already Burst as Tech-Heavy STAR50 Index Crashes 40% and Wipes Out $480 Billion in Value

HONG KONG, Oct. 26 — Global investors are still debating whether artificial intelligence stocks are in a bubble. In China, that bubble appears to have already burst.

The STAR50 index, which tracks the biggest companies on Shanghai's Nasdaq-style STAR Market and is heavy with AI and semiconductor stocks, has fallen about 40% from its July peak in less than four months. The slide has erased roughly $480 billion in market value, according to Reuters.

The reversal has ended a rally that began about two years ago, when promises of economic stimulus sent Chinese shares soaring. It is also a setback for Beijing's efforts to steer household savings into the stock market to help fund the country's AI ambitions.

The broader pain has spread well beyond the STAR Market. China's CSI 300 index of blue-chip stocks has fallen about 20% from its June high.

From 'slow bull' to burst bubble

Chinese authorities have spent the past two years trying to break the market's long history of booms and busts and cultivate what officials call a "slow bull" market with steady, reliable gains. Regulators cracked down on leverage and high-frequency trading, and state-backed investors sold into rallies to keep gains in check.

Some fund managers say the AI frenzy overwhelmed those efforts.

"The stock market later evolved into a speculative crazy bull," Beijing-based fund manager Dong Baozhen told Reuters. "And now we see the bubble bursting."

Traders said there was no single trigger for the sell-off. They cited stretched valuations, tax bills and the threat that the United States or other countries could ban Chinese equipment from their data centers.

The decline in China has been far steeper than in the West. The U.S. Nasdaq Composite, led by AI stocks, is down about 6% from a record high reached three weeks ago.

AI dominates the market

The losses have hit a large share of Chinese investors because AI-related stocks dominate trading. According to Goldman Sachs, AI stocks make up 42% of the market capitalization of mainland-listed A-shares and Hong Kong-listed H-shares, and account for 57% of turnover.

China's stock market is dominated by retail investors, and many of the hardest-hit companies were popular with small buyers:

• Unitree: Shares of the humanoid robot maker have fallen by half since they began trading in August. Retail investors oversubscribed its listing about 8,000 times.
• CXMT: The memory chipmaker has lost more than a quarter of its value in the past month.
• MetaX Integrated Circuits and Moore Threads Technology: Both chipmakers have fallen by about half since July. They had surged 700% and 400%, respectively, on their market debuts last year.
• Zhongji Innolight and Eoptolink Technology: Shares of the optical component makers are down about 60% from their June and July highs, partly because Washington is moving toward barring them from supplying U.S. data centers.

Chen Wensheng, a small business owner in southern Hainan province, told Reuters that he joined the rally partly because he believed companies such as Unitree, which counted state-backed funds among its investors, had official support. He and his friends are now sitting on losses.

Analysts say frustration that a Beijing-backed investment theme has ended so badly has pushed many investors into defensive assets.

IPO pipeline at risk

The collapse could make it harder for Chinese technology companies to raise money, just as Beijing wants capital markets to fund its push for technological self-reliance.

"What's happening is now going to put a stop for many of the companies trying to get themselves listed," said Hong Hao, managing partner and chief investment officer at Lotus Asset Management in Hong Kong.

Valuations also remain high despite the sell-off, raising the possibility of further losses. The STAR50 still trades at around 100 times trailing earnings, down from a peak of nearly 250 times. By comparison, the Nasdaq 100 trades at about 30 times earnings.

Questions over market structure

Some investors argue that the policy focus on technology distorted the market.

"Overemphasising the 'technology content' — that is, the weighting of tech companies by market value in major indexes — leads to a deviation, even a distortion, in capital behaviour," said Leo Wang, a partner at Beijing-based Qianchuang Capital.

"This created a severe bubble in certain sectors and a serious drain on others," he said.

The China Securities Regulatory Commission did not immediately reply to Reuters' questions. Earlier this month, CSRC Chairman Wu Qing met market participants to hear suggestions on improving the country's capital markets, according to the regulator's website.

The market turmoil coincides with a key meeting of the ruling Communist Party, where President Xi Jinping opened a plenum focused on governance.

Some see buying opportunities

Not everyone is bearish. Some analysts say the correction is neither surprising nor harmful to long-term market reforms, which have helped lift shareholder returns, particularly dividends, in recent years.

Asia-focused funds remain overweight Chinese stocks overall, even though they have been net sellers over the past three months, according to HSBC research.

Goldman Sachs earlier this month included Innolight and CXMT among dozens of Chinese AI stocks on a revamped recommendation list. BNP Paribas Securities strategist William Bratton has said the market offers buying opportunities for careful investors.

Still, many mainland investors are waiting for lower prices or looking at other sectors. Some fund managers warn that Chinese chipmakers and AI suppliers will face the same intense competition that has squeezed profits in other Chinese industries.

"Just like all other Chinese manufacturers, (chipmakers and AI suppliers) will eventually end up in a price war," said Wang Zhuo, a partner at Shanghai Zhuozhu Investment Management. "There's no exception. All bubbles inevitably burst."

Warning for global markets

China's sell-off comes at a fragile moment for global technology stocks. Investors worldwide are questioning the huge sums being spent on AI infrastructure, including recent plans by U.S. tech giants to raise more capital for data centers.

Major U.S. technology companies, including Alphabet, Microsoft, Amazon and Meta Platforms, report earnings this week. Their spending forecasts will be closely watched for signs of whether the AI boom is cooling outside China as well.