CITIC Securities: The current Hong Kong stock market rally is expected to continue until early November

The new round of interest rate cuts initiated by the Federal Reserve and the policy package launched domestically on September 24 significantly boosted investor confidence in the Hong Kong stock market. On one hand, Hong Kong stocks are more sensitive to real estate and consumption policies compared to A-shares, and on the other hand, it also helps in the inflow of foreign and local funds back into Hong Kong stocks.

In addition, data since 1976 shows that Hong Kong stocks tend to have relatively higher returns before the U.S. presidential elections compared to after the elections. Since early August this year, valuations, trading volumes, and fund flow indicators all indicate a re-emergence of market bottom characteristics seen since 2022. Although the 24H1 interim reports of Hong Kong stocks still show pressure on the revenue side, companies' cost reduction and efficiency improvement measures have significantly boosted profit margins and ROE, especially against the backdrop of a noticeable increase in share buybacks. Currently, major indices of Hong Kong stocks are still at historically low valuations, with valuations of major financial, consumer, healthcare, and technology sectors at around the 10th percentile or lower in historical terms. Therefore, we believe that the valuation recovery trend in the Hong Kong stock market since early August is likely to continue until early November, with growth styles expected to continue outperforming dividend strategies.

We recommend focusing on two main themes: 1) the financial sector benefiting from continued policy implementation and the reversal of pessimistic sentiment, especially non-bank financial institutions such as insurance; 2) the consumer and technology sectors expected to continue the valuation recovery trend, including internet, biotechnology, education, and consumer electronics.

Events:

Boosted by the Federal Reserve's interest rate cuts and the policy package on September 24, Hong Kong stocks saw significant gains. Since September 16, the Hang Seng Index, Hang Seng China Enterprises Index, and Hang Seng Tech Index have risen by 9.5%, 11.4%, and 12.8% respectively. Our comments on this are as follows:

The Federal Reserve's interest rate cuts open up policy space domestically, potentially leading to the inflow of local funds back into Hong Kong stocks.

The policy package on September 24 is favorable for stabilizing property expectations and boosting confidence in the capital markets. With the real estate, financial, and consumer-related industries accounting for 67.7% of Hong Kong stocks, which is 26 percentage points higher than the corresponding industries in A-shares, Hong Kong stocks will benefit more from the introduction of growth-stabilizing policies. Starting from the second half of 2023, based on calculated custodial funds, local funds in Hong Kong have continued to flow out of the stock market, amounting to HKD 277.5 billion. With the start of the Federal Reserve's interest rate cut cycle, on one hand, the Hong Kong Monetary Authority will gradually follow the Federal Reserve in lowering interest rates, and on the other hand, it will open up space for domestic policy easing, potentially leading to the gradual return of previously outflowing local funds and foreign funds to the Hong Kong stock market.

The dust settling on the U.S. presidential election results is expected to have relatively limited impact on Hong Kong stocks.

As the U.S. presidential election schedule approaches, the Hong Kong stock market has shown a pattern of strength in the early stages followed by weakness in the later stages during election cycles. Looking back to 1976, using the U.S. election voting day as a reference point, within 30 natural days before and after the election day, when the dust settles on the U.S. election results, the disturbance to the Hong Kong stock market is relatively limited. On the contrary, during the intense competition phase of the U.S. election, the performance of the Hong Kong stock market often outperforms the period after the election day. Considering the bursting of the U.S. technology stock bubble in 2000 and the extreme impact of the global financial crisis in 2008, global assets were generally under pressure in those yearsTherefore, excluding abnormal years, the Hang Seng Index had an average increase of 5.8% in the 30 natural days before the election day. However, as the election day approaches, the Hang Seng Index's increase shows a trend of gradual convergence, with an average increase of only 0.6% in the 30 natural days after the US election day.

Characteristics of the bottom of the Hong Kong stock market have gradually emerged since August.

From multiple indicators, the characteristics of the bottom of the Hong Kong stock market have become more apparent since August. Looking at market sentiment-related indicators, the Hang Seng Index and the Hang Seng Composite Index's ERP have risen to 9.1% and 8.8%, respectively, which are more than one standard deviation above historical averages; the Hang Seng Index's dividend yield in the past 12 months has risen to 4.5%, surpassing the level in January of this year. In terms of trading volume, the average daily turnover in the Hong Kong stock market from August 12 to 14 was only HKD 70 billion, indicating that market sentiment was at an extremely low level. However, the average daily turnover in the recent 10 trading days has significantly increased to nearly HKD 120 billion. Looking at short selling and fund flows, the short selling amount in the Hong Kong stock market reached a historical high of 20.9% on August 23; it has shown a significant decline recently, dropping to 13.9% as of September 25, indicating a significant rebound in short-term fund sentiment. From May to August, foreign capital flowed out of the Hong Kong stock market again. On August 23, the proportion of foreign holdings fell to a historical low of 72.4%; since late August, we have observed a steady increase in the proportion of foreign holdings, which has now risen by 0.5 percentage points to 72.9%.

Although the semi-annual report faces pressure on the fundamentals, cost reduction and efficiency improvement have increased profit margins and ROE.

In the first half of 24H1, Hong Kong stocks experienced a year-on-year negative revenue growth of 4.4% under pressure from the Chinese economy, but the promotion of cost reduction and efficiency improvement still led to a year-on-year increase in net profit of 0.8%. Although both figures fell short of expectations, net profit margins and ROE continued to rise in the first half of this year, indicating a continuous enhancement of operational efficiency. Looking at the industry, the pressure on revenue exists across industries, with only the optional consumption, information technology, and telecommunications sectors showing revenue relatively in line with expectations. Profit growth is only supported by the growth sector, mainly driven by technology and pharmaceutical stocks exceeding expectations under cost reduction and efficiency improvement, while the enhancement of operational efficiency is widely seen across industries. In addition, the upward trend in shareholder cash returns (buybacks plus dividends) in 24H1 has pushed Hong Kong's ROE to 4.7%, an increase of 0.2 percentage points year-on-year. The number of buyback cases this year has also significantly increased, from 169 cases for the entire previous year to 394 cases, highlighting the value of Hong Kong stocks gradually.

Current valuations of Hong Kong stocks are still at historically low levels, with strong upward potential.

After nearly two weeks of valuation repair, the current dynamic PEs of the Hang Seng Composite Index, the Hang Seng Index, and the Hang Seng Technology Index are still at historical lows, at 8.9/8.7/14.0 times, respectively, representing 11.1%/11.5%/6.9% of the historical percentile since 2015. Although the valuation of the Hang Seng State-Owned Enterprises Index is at the 36.8% historical percentile, higher than other indices, there is still significant room for a rebound from historical averages. Looking at different industries, sectors such as optional consumption, essential consumption, information technology, and healthcare currently have PEs at relatively low historical percentiles, at 0.5%/3.1%/10.3%/10.3% respectively;The real estate construction and financial sectors have relatively low PB valuations of 5.2% and 8.7% respectively, still with significant upside potential.

Allocation Suggestions:

Based on the above analysis, with the characteristics of the bottom of the Hong Kong stock market reappearing, gradual realization of performance expectations, the Fed starting an interest rate cut cycle, and increased room for domestic policy response, we believe that the valuation recovery trend in the Hong Kong stock market since early August is expected to continue until early November. In addition, if the expectation of the real estate cycle stabilizes, the growth style is expected to continue to outperform the dividend strategy. Under the benchmark scenario, we recommend focusing on two main themes: 1) the financial sector benefiting from continued policy implementation and the reversal of pessimistic sentiment, especially non-bank financial institutions such as insurance; 2) the consumer and technology industries where valuation recovery is expected to continue, including the internet, biotechnology, education and training, and consumer electronics.

Author: Wang Yihan (SAC License No.: S1010522050002), Source: CITIC Securities Research, Original Title: "Hong Kong Stock Strategy | Rebuilding Confidence, Focus on Growth", with some deletions by Wall Street News