Market sentiment is high, how much room is left under the new round of policies?
CICC pointed out that market sentiment is high, with current sentiment levels comparable to the high point in May, corresponding to 22,500 points for the Hang Seng Index if it returns to the high point in 2023. Foreign capital is mainly focused on trading and passive funds, while long-term active foreign capital has not yet returned on a large scale. In the short term, the main direction of the rebound is distressed state-owned enterprises trading below net asset value and oversold sectors. In terms of policies, fiscal expansion and interest rate cuts are key factors. Boosted by financial policies and the central conference, the market has seen a strong rebound, with both A-shares and Hong Kong stocks reaching historic highs in trading volume
After the astonishing rebound in market sentiment last week, which even reached a state of "overbought", we will focus on answering the following questions in this article:
What are the core changes in this round of policies? Directly encouraging the stock market and real estate, emphasizing a different policy approach for consumer livelihood consumption transmission.
How much policy is enough? Fiscal policy remains crucial, with a 45-70 basis point interest rate cut, fiscal expansion of 7-8 trillion yuan can reverse the yield curve inversion.
How much room does the market have left? The current sentiment level is similar to the peak in May, if sentiment returns to the peak in 2023, it corresponds to the Hang Seng Index at 22,500 points.
Who is buying? Are foreign funds returning? Trading and passive funds are the main players, long-term active foreign funds have not yet returned in large numbers.
Direction for short-term speculation and long-term allocation? Short-term focus on stocks with a price-to-book ratio below 1 and lagging sectors. Fiscal efforts shift towards cyclical and core assets. Otherwise, technology growth, internet, export chains, and local stocks.
In the last week of September, the policies of the three financial departments and the Central Political Bureau meeting exceeded expectations, boosting market sentiment. A-shares and Hong Kong stocks saw a strong rebound, leading global markets. The Shanghai Composite Index surged by 12.8%, marking the largest weekly gain since the end of 2008, reclaiming the 3,000-point level. The Hong Kong stock market showed even greater resilience, with the Hang Seng Index rising by 13.0%, the largest weekly gain since 2000, surpassing 20,000 points. Hang Seng Enterprises and MSCI China rose by 14.4% and 16.8% respectively, while Hang Seng Tech soared by 20.2%. The soaring sentiment also drove record-high trading volumes in both markets, with the main board turnover in Hong Kong exceeding HKD 400 billion on Friday, reaching a historical high. A-share turnover also reached 14.6 trillion RMB, the highest since September 2021. In terms of sectors, real estate (+34.1%) and diversified finance (+25.5%) benefited directly from positive policy expectations, leading the gains. Food retail (+27.1%), food and beverage (+25.3%), retail (+24.0%), insurance (+23.5%), and internet (+20.6%) also performed well, while traditional high-dividend sectors such as telecommunications (+1.1%), banks (+8.8%), and energy (+9.6%) lagged behind.
Chart: Strong rebound in A-shares and Hong Kong stocks
Source: Wind, CICC Research Department
Chart: Chinese market leading global markets
 Hong Kong stocks have greater resilience, as their earnings are better, valuations and positions are more thoroughly cleared ("Hong Kong stocks have greater resilience"). 2) Hong Kong stocks are more sensitive to the Fed rate cuts. In our analysis in "How much rebound space is there after the rate cut lands?", solely relying on the Fed rate cuts and risk premium returning to the 5-year average, the Hang Seng Index is expected to reach 19,500-20,500, which it has already reached. 3) It is recommended to focus on interest rate-sensitive growth stocks, export chains driven by U.S. real estate demand, local dividends and real estate in Hong Kong, all showing greater resilience in this uptrend ("How much rebound space is there after the rate cut lands?").
However, the fear of missing out (FOMO) has led to emotions entering very quickly, with even several technical indicators being somewhat "overbought" in the short term. For example, the 6-day RSI (Relative Strength Index) of the Hang Seng Index has reached 96.5, the highest since the end of 2018, and the Shanghai Composite Index has also reached 94.1, indicating a short-term "overbought" condition. Additionally, unlike before, short selling volume in Hong Kong has increased with the market rise, and the short selling ratio has also temporarily risen, indicating some divergence in market views on future trends. So, after the significant rise in the past week, how much room is there for further growth? Which sectors are recommended for allocation? How should we view the impact of the new round of policies, how much of it has been priced in by the market? Which funds are the main buyers?
Q1. What are the core changes in this round of policies? Encouraging leverage in the private sector (stock market and real estate), emphasizing different signals and ideas related to livelihood and consumption transmission
In several previous reports, we have analyzed the root cause of China's current growth and inflation pressure issues from the perspective of the credit cycle, highlighting the continuous credit contraction as the source of the problem, especially the ongoing deleveraging in the private sector, while the government's credit expansion, which could serve as a hedge, has been slow and insufficiently effective ("Viewing the China-U.S. cycle mismatch from the credit cycle," "Where did the money go?", "Where did the leverage go?"). There are two reasons for this situation: 1) Expectations of low investment returns, directly reflected in the downward trend of asset prices, especially the stagnation of real estate and stock prices; 2) Financing costs are not low enough, especially when considering the real interest rates after deducting price factors, which may even be higher than the significant rate hikes in the U.SThe "combination punch" of financial policies on September 24th and the Political Bureau meeting on September 26th, along with subsequent policy adjustments and statements, are all aimed at reducing financing costs (lowering multiple interest rates) and boosting investment return expectations (stabilizing housing prices and providing liquidity support to the stock market). We believe that the core of this round of policy changes, and the reason for the positive market response, lies in two main aspects: firstly, directly encouraging leverage in the private sector (stock market and real estate) through various financial policies, and secondly, emphasizing more on people's livelihoods and consumption, conveying signals and strategies that are somewhat different from the past.
► On one hand, continuing to push for lower financing costs and leverage thresholds, specific policy measures include: 1) a 20 basis point interest rate cut, with the 7-day reverse repurchase operation rate lowered by 20 basis points from 1.7% to 1.5%, with a high proportion of residential credit being mortgage loans (75%) and corporate financing being mainly indirect financing (70%). Whether it's residential mortgage rates or corporate loan rates, they are closely related to the Loan Prime Rate (LPR). We estimate that the current residential mortgage rate (3.35%) is higher than the investment return measured by rental yield in first-tier cities (approximately 1.74%), and the weighted average interest rate on corporate loans (3.63%) is higher than the corporate ROA level (2.87%). The downward adjustment of the LPR will help push down the financing costs for residents and enterprises; 2) reducing the down payment ratio to 15%, unifying the down payment ratio for first and second homes, with the down payment ratio for second homes reduced from 25% to 15%, lowering the threshold for residential mortgage loans; 3) lowering the interest rates on existing mortgages to the level of new loans, with an average reduction of 50 basis points. PBOC Governor Yi Gang stated that this move is expected to help 50 million families reduce their annual interest expenses by an average of 3,000 yuan, while also easing the pressure on residents to repay loans early; 4) a 50 basis point reserve requirement ratio cut, providing long-term liquidity of 1 trillion yuan. Depending on the liquidity situation, there may be a further reduction of 25-50 basis points in the future.
► On the other hand, focusing on stabilizing asset prices and investment return expectations. The overall easing direction of interest rate cuts and reserve requirement ratio reductions continues the previous loose stance, with the magnitude largely within expectations. The more unexpected incremental changes lie in stabilizing asset prices and investment return expectations, reflected in policy innovations and target statements: 1) the central bank has introduced two new structural monetary policy tools to stabilize stock prices, one being the tool for securities, fund, and insurance companies to exchange assets, encouraging non-bank financial institutions to leverage up in stock market investments, with an initial operation scale of 500 billion yuan and a possible additional scale of 5,000-10,000 billion yuan in the future; the other being a special re-lending facility for stock repurchase and holdings, with an interest rate of only 2.25%. This move is equivalent to injecting incremental funds into the stock market, with an initial quota of 300 billion yuan and a possible additional scale of 3,000-6,000 billion yuan in the future. 2) Targeted statements explicitly aim to stabilize real estate prices, with the Political Bureau meeting for the first time clearly stating the goal of "promoting the stabilization of the real estate market," significantly exceeding market expectations. Policies on the demand and supply sides of the real estate market may be accelerated or strengthened► In addition, the statements made at the Politburo meeting regarding fiscal policy and the focus on people's livelihoods and consumption convey a slightly different approach and signal from the past, which could have a greater impact if implemented. The most surprising statement in the meeting summary is the emphasis on consumption and people's livelihoods, pointing out the need to "combine promoting consumption with benefiting people's livelihoods to increase the income of middle and low-income groups." In terms of fiscal policy deployment, it is proposed to increase the intensity of counter-cyclical fiscal policy adjustments to ensure necessary fiscal expenditures; to issue and use ultra-long-term special national bonds and local government special bonds more effectively to enhance the role of government investment. The market expects the possibility of a stronger fiscal policy, especially in areas with higher fiscal multipliers such as demand-side and household-side investments.
Q2. What are the expectations for the future, and how significant are the policies? We statically calculate that a 45-70 basis point rate cut and a fiscal expansion of 7-8 trillion yuan are expected to reverse the yield curve inversion.
The positive change in policy thinking is very important, but what is more crucial is the fundamental means that bring about this change, namely fiscal policy, whether the pace is fast enough and the intensity is sufficient. Otherwise, it may be difficult to find clear support after being driven by emotions and liquidity.
Based on this consideration, starting from the difference between the return on investment and the cost of financing mentioned above, we update the calculation of how much policy intensity is needed to solve this yield curve inversion problem. It should be noted that this calculation is based solely on a static perspective with strong assumptions, aiming to provide investors with a reference for observing policy intensity. Specifically,
► A rate cut of 45-70 basis points can solve the problem of high financing costs. Our static calculation shows that a 5-year LPR (likely to decrease to 3.65% in October) further decreasing by 45-70 basis points to 2.95%-3.2% will help solve the current issue of investment returns being lower than financing costs: 1) In terms of residential real estate investment, to align mortgage rates (3.35%, likely to decrease to 3.15% in October) with rental returns in first-tier cities (1.74%), a decrease of approximately 140 basis points in mortgage rates is needed, corresponding to a downward movement of about 45-70 basis points in the 5-year LPR; 2) In terms of corporate investment, to align the weighted average interest rate on loans to enterprises by financial institutions (3.63%, likely to decrease to 3.43% in October) with the return on assets of A-share non-financial listed companies (2.87%), a 60 basis point decrease in the weighted average interest rate on corporate loans is needed. Considering that small and medium-sized enterprises may face higher costs of private borrowing and weaker profit capabilities, a greater reduction in the benchmark interest rate may be needed to meet their needs.
Chart: Intensive policy implementation exceeds expectations in stabilizing growth and market confidence
Data source: Chinese government website, CICC Research Department
Chart: Mortgage interest rate (3.35%, likely to decrease to 3.15% in October) higher than rental yield in first-tier cities (1.74%)
Data source: Wind, CICC Research Department
Chart: Weighted average interest rate on corporate loans (3.63%, likely to decrease to 3.43% in October) higher than ROA of A-share non-financial listed companies (2.87%)
Data source: Wind, CICC Research Department
► Fiscal increment of 7-8 trillion yuan may boost investment return expectations. Compared to interest rate cuts that broadly lower various private sector financing costs, more importantly, it boosts investment returns. Otherwise, a single monetary easing may lead to a "liquidity trap," where although financing costs decrease rapidly, private sectors are unwilling to "leverage up" due to lower investment return expectations, highlighting the necessity of fiscal efforts.
The current fiscal scale and pace both need to be strengthened. From a fiscal pulse perspective, despite rising to 1.4% in July due to base effects, it weakened again in August and still lags behind the historical peak (4%). If expenditures are made based on the deficit ratio at the two sessions, special treasury bonds, and government special bonds arrangements, we estimate that the broad fiscal deficit pulse may decrease to 0.4% by the end of the year. To bring the fiscal pulse back to historical highs or return the overall social financing growth rate from the current 8.1% to 10% in early 2023, our updated calculation indicates the need for an additional issuance of 7-8 trillion yuan.
Chart: If the broad fiscal deficit pulse returns to the historical peak (4%) by mid-next year, corresponding to an expansion of the broad deficit scale by 5-6 trillion yuan
Source: Wind, CICC Research Department
Chart: Significant decline in private sector social financing growth rate, while government sector credit expansion has not provided sufficient hedging
Source: Wind, CICC Research Department
Chart: Social financing growth rate repaired to 10% within the year (level at the beginning of 2023), requiring an additional issuance scale of 7-8 trillion yuan
Source: Wind, CICC Research Department
Chart: Social financing growth rate repaired to 10% by mid-next year (level at the beginning of 2023), requiring an additional issuance scale of 2-3 trillion yuan
Source: Wind, CICC Research Department
From this perspective, there is still a gap in current market expectations. The market expects a certain scale of fiscal stimulus in the near term to "accurately" address the pressures of low inflation and weak domestic demand, but it may be difficult to fully offset the continued decline in private credit in terms of magnitude. In addition, the speed of fiscal efforts is particularly important, as in May of this year, we estimated the need for an additional issuance scale of 4-5 trillion yuan, but fiscal issuance and expenditure progress has been slow. Against the backdrop of accelerated private sector credit contraction, the required incremental scale has further expanded ("Global Market Outlook for the Second Half of 2024: Easing is already halfway through").
Therefore, the key points to observe in the future are: 1) the strength and speed of fiscal efforts; 2) the specific terms and funding availability of two innovative financial instruments that directly encourage the private sector to leverage the stock market.
Q3. How much expectation has the market priced in, and how much room is left? Optimism has reached levels close to May of this year, corresponding to around 22,500 for the Hang Seng Index in early 2023
Compared to the market sentiment of "rushing ahead", the risk-free interest rate is relatively stable while profits react more slowly. Therefore, the equity risk premium has become the best indicator to depict short-term market expectations, whether it is optimistic policy expectations or direct liquidity injection. During the week of September 29th, the MSCI China Index rose by 16.8%, largely contributed by the decline in equity risk premium, with risk-free interest rates rising instead of falling, and EPS making only a small contribution. Currently, the Hang Seng Index's risk premium has rapidly fallen from its peak of 9.5% on September 11th to 7.3%, a decrease of 2.3 percentage points, approaching the historical average since 2018 and hitting a new low since June 2024. Roughly speaking, the current optimism included is comparable to the market peak in late May, possibly not as high as the sentiment at the beginning of 2023.
Chart: Rapid repair of risk premium is the main contribution to this round of market rebound
Source: Bloomberg, CICC Research Department
Chart: Hang Seng Index's risk premium falls to 7.4%
Source: Bloomberg, CICC Research Department
How much room is there for further development? Assuming that the risk-free interest rates in China and the US remain unchanged in the short term, and profit improvement is still pending: 1) If the risk premium falls to 6.7% at the market peak in May 2024, or supports the Hang Seng Index to around 21,000 points; 2) If sentiment continues to improve to 6.1% corresponding to the peak after the initial easing of the epidemic in early 2023, the Hang Seng Index may reach around 22,500 points. On this basis, greater room for growth requires profit recovery driven by fiscal efforts. Currently, we estimate a 2-3% increase in full-year profits for 2024 from the bottom up. If profit growth can be restored to 10%, the Hang Seng Index may reach around 24,000 points.
Chart: Risk premium falls to the low point in May or supports the Hang Seng Index to reach around 21,000 points, greater room for growth requires profit recoverySource: Bloomberg, CICC Research Department
In the short term, market expectations are relatively full. On the one hand, the risk premium is rapidly falling, and on the other hand, technical indicators also show that the short term may be "overbought": 1) The 6-day RSI of the Hang Seng Index has reached 96.5, the highest since the end of 2018, and the Shanghai Composite Index has also reached 94.1, the highest since the end of 2020. 2) The proportion of short selling transactions in the rebound of Hong Kong stocks has increased, and the scale of short selling transactions has continued to rise. Currently, the average short selling ratio of Hong Kong stocks has reached 17.5% in the past 5 days, up from 15.6% last week. Historically, the inverse relationship between the short selling ratio and the market often indicates a divergence in market sustainability, as well as the importance of subsequent fundamentals and policy developments for market trends.
Chart: Hang Seng Index 6-day RSI reaches 96.5
Source: Wind, CICC Research Department
Chart: Shanghai Composite Index 6-day RSI reaches 94.1
Source: Wind, CICC Research Department
Chart: The short selling ratio is usually negatively correlated with market trends, but there have been cases where the market has risen while the short selling ratio has increased from a low pointSource: Bloomberg, CICC Research Department
Q4, Who are the main buyers? Trading and passive funds dominate, long-term foreign capital has not yet flowed in significantly, and some profits have been taken by southbound funds
The nature of the funds during the rise also has an important impact on the sustainability of the subsequent rebound. We have integrated various data sources (EPFR, Shanghai-Hong Kong Stock Connect, etc.) and combined them with client communications to find: 1) Long-term foreign capital has not yet flowed in significantly. We have detailed the composition and observation methods of foreign capital in "How to characterize and analyze foreign capital?" EPFR's active funds can be used as an important window to characterize long-term institutional investors (Long Only), and there was outflow in the week of September 29. At the same time, feedback from our clients also largely confirms this point, that long-term foreign capital is more about reducing underweight positions to prevent significant underperformance, rather than aggressively increasing positions. 2) Trading and passive funds may be dominant. Trading funds such as hedge funds act faster and more flexibly, similar to the situation during the sharp rise in Hong Kong stocks in April-May. As mentioned earlier, short selling in the market has also increased during the market's rise, indicating the long and short game of funds. In addition, there has been a significant increase in passive fund inflows from EPFR, which may more reflect the behavior of non-institutional investors, explaining the sharp rise in index heavyweight stocks. 3) Southbound fund inflows have narrowed or even turned negative, with some leading stocks that have performed well in the rise experiencing overall net selling from the southbound funds, which may be due to profit-taking or rebalancing behavior ("Who are the main buyers?").
Reviewing historical experience, trading and passive funds tend to flow in early during a rebound due to their flexibility, but they also face the issue of lack of sustainability. The most typical example is the rapid inflow of trading funds during the sharp rise in April-May this year, but active foreign capital from EPFR did not show a clear return flow, leading the market to turn into a consolidation phase. Conversely, if the restoration of fundamentals drives more active long-term funds to return, the market space will be larger. By the end of 2022, the market rebounded continuously for 3 months starting from the end of October, during which MSCI China surged nearly 60%, passive foreign capital gradually flowed in from late September, while active foreign capital started to flow in after the market rose for 2 months, from early January with a 40% increase, until early March, when the market peaked.
Chart: Accelerated outflow of active foreign capital from A-share and Hong Kong stock markets
Source: Wind, CICC Research Department
Chart: Passive foreign capital turns into inflows into the Chinese market
Data source: Wind, EPFR, CICC Research Department
Chart: The inflow of funds is mainly from partially hedged trading funds and passive funds
Data source: EPFR, CICC Research Department
Chart: Passive foreign capital has led the market rebound at the end of 2022, while active foreign capital lags behind to some extent
Data source: EPFR, Bloomberg, CICC Research Department
It is evident that long-term funds have a lag but are also more critical. Currently, the allocation of major active funds globally to Chinese stocks has decreased from a high of 14.6% in early 2021 to 5.0% in August this year, 1 percentage point lower than passive funds. We estimate that a shift from underweight to neutral allocation could bring in nearly $40 billion, equivalent to the total outflow since March 2023.
Chart: The allocation of major active funds globally to Chinese stocks has decreased to 5.0% in August, 1 percentage point lower than passive funds
Source: EPFR, CICC Research Department
Q5. How to trade the rebound? Short-term focus on undervalued state-owned enterprises and lagging sectors; if fiscal stimulus favors the cyclical sectors, otherwise focus on structural opportunities
In the short term, undervalued state-owned enterprises and previously oversold sectors are still the direction of market rebound game. On the one hand, financial innovation tools of the central bank may directly benefit undervalued enterprises, especially state-owned enterprises. We have selected relevant individual stocks for investors to refer to in the original report. On the other hand, lagging sectors such as internet software (-24.8% since the beginning of 2024), food retail (-16.6%), and medical equipment services (-14.8%) may also be the direction of the emotional-driven rebound game.
If policies continue to be fulfilled and fiscal stimulus exceeds expectations, cyclical sectors directly benefiting are expected to outperform, including consumption, real estate chain, and non-banking financials. In addition, we continue to recommend focusing on interest rate-sensitive growth stocks (internet, technology growth, biotechnology, etc.), Hong Kong stocks with local dividends and real estate, as well as export chains driven by US real estate demand. However, if fiscal stimulus is insufficient or slower than expected, the market may need to digest through volatility. In this case, high dividends still have long-term allocation value, and investors can take advantage of recent pullbacks to enter the market at the right time, following the economic environment along the cycle dividends, bank dividends, defensive dividends, government bonds, and cash in that order. Secondly, some sectors supported by policies or with positive economic outlook are still expected to be boosted by favorable factors and show greater resilience, such as those with their own industry prosperity (internet, gaming, education) or technology growth supported by policies (technology hardware and semiconductors). For details, refer to the selected content in the original report.
Chart: Performance lag of sectors such as internet software, food retail, and medical equipment services since the beginning of the year
Source: FactSet, CICC Research Department
Chart: If fiscal stimulus favors cyclical sectors, otherwise focus on structural opportunities
![](https://mmbiz-qpic.wallstcn.com/sz_mmbiz_png/fzHRVN3sYsibKoR1FbwOh6aJ6OoQdNKx52bU79SnBkCORI5SyT8ice5wIzMOeicW0MzPJLgibpEDtDKJ06iclRQnVtg/640?Source: Wind, CICC Research Department
[1] https://www.gov.cn/zhengce/202409/content_6976189.htm
[2] https://www.gov.cn/yaowen/liebiao/202409/content_6976686.htm
[3] https://www.gov.cn/zhengce/202409/content_6976145.htm
[4] https://www.gov.cn/zhengce/202409/content_6976145.htm
[5] https://www.gov.cn/zhengce/202409/content_6976189.htm
[6] https://www.gov.cn/zhengce/202409/content_6976189.htm
Authors: Liu Gang, Wang Muyao, Wang Zilin, Source: CICC Insight, Original Title: "CICC: Market Space Under the New Round of Policies"