Strategy | Can Hong Kong stocks continue the "Chinese New Year offensive"?

Source: Kevin's Strategic Research

In just three trading days after the Spring Festival holiday, despite the lack of southbound funds and disturbances from US bond rates and US stocks, the Hong Kong stock market still managed to achieve a strong rally. So, what special factors have led to this "contrarian" strong performance?

More importantly, can this rebound rally continue?

First of all, sectors closely related to Spring Festival holiday consumption were the main drivers of the rise, such as textiles and apparel, hotels and catering, media, and food retail, all with gains exceeding 8%. Secondly, the expectation of more favorable policies to be introduced in the future, including further interest rate cuts, may be another factor. Thirdly, the current high risk premium and low valuations not only enable the Hong Kong stock market to withstand certain external disturbances but also provide the possibility for a market rebound under certain positive catalysts.

However, there are still uncertainties in the current rebound:

1. The cooling of expectations for a Fed rate cut may drive up US bond rates, and there may still be uncertainties and disturbances ahead;

2. Data monitored by EPFR shows that overseas active funds have not yet returned;

3. The seemingly strong consumption recovery during the Spring Festival period also has certain structural differences and a situation of increasing quantity but decreasing price. The core factor for the sustainability of the current rebound rally is still a targeted and robust fiscal policy.

Looking ahead, whether the MLF and LPR will be lowered in February, policy signals from the two sessions in early March, and the minutes of the FOMC meeting on February 22 are all key focal points to watch. In the current market environment, we recommend investors to focus on the short-term opportunities brought by the "expectation of policy support," but in the medium term, unless there is substantial and large-scale policy implementation in finance and real estate, high dividends and a "dumbbell" allocation strategy will remain effective.

01 Market Trend Review

In just three trading days after the Spring Festival holiday, despite disturbances caused by the rise in US bond rates, the Hong Kong stock market's strong performance exceeded the expectations of most investors. Among the main indices, the Hang Seng Tech Index led with a 6.9% increase, followed by gains of 4.8% for the Hang Seng China Enterprises Index, 3.8% for the Hang Seng Index, and 3.7% for the MSCI China Index. In terms of sectors, consumer discretionary and real estate sectors rose by 6.5% and 6.1% respectively last week, while the telecommunications sector lagged behind, falling by 0.9%.

Chart: MSCI China Index rose by 3.7% last week, with consumer discretionary and real estate sectors leading the gains

02 Market Outlook

Despite the lack of southbound funds and disturbances from US bond rates and US stocks, the Hong Kong stock market still managed to achieve a strong rally, which was indeed somewhat unexpected, as the Hong Kong stock market has always been highly sensitive to various disturbances at home and abroad. So, what special factors have led to this "contrarian" strong performance? And more importantly, can this rebound rally continue?Firstly, by observing the driving force behind the market rebound, it is not difficult to find that sectors closely related to consumer spending during the Spring Festival are the main drivers of the rise, such as textiles and clothing, hotels and catering, media, and food retail, all with increases of over 8%. The service consumption industries like tourism, catering, and box office have shown strong performance during the Spring Festival holiday. According to the Ministry of Transport statistics, the average daily passenger volume of civil aviation from New Year's Eve to the sixth day of the Lunar New Year was 2.16 million, a 20% increase from the same period in 2019; in terms of ticket prices, the average domestic/international ticket prices from New Year's Eve to the sixth day of the Lunar New Year increased by 20%/8% compared to the same period in 2019. In terms of catering, Meituan statistics show that in the first 5 days of the Spring Festival holiday, the order volume of group dining packages nationwide increased by 161% compared to the same period in 2023. Movie consumption is also very hot, as of February 17, the total box office of the 2024 Spring Festival nationwide exceeded 8 billion RMB, setting a new record for the Chinese film history Spring Festival box office.

Chart: Expected record high travel volume during this year's Spring Festival travel season

Source: Ministry of Transport, Zhongjin Research Department, "0" represents the first day of the Lunar New Year

Secondly, the expectation of more favorable policies to be introduced in the future, including the anticipation of further interest rate cuts, may be another factor. The hint from Governor Pan before the Spring Festival's reserve requirement cut and the further decline in January's inflation data have raised market expectations for a possible interest rate cut after the holiday (MLF and LPR on February 18 and February 20 respectively). Further interest rate cuts are necessary and can effectively reduce the actual financing costs compared to reserve requirement cuts. The unexpected absence of an interest rate cut last month directly led to market selling to a certain extent, so investors have high expectations for the potential interest rate cut that is coming. If these expectations can be met, we believe that the current market rebound still has certain momentum. In addition, some positive changes at the regulatory level have also fueled optimistic market sentiment.

Thirdly, as we have pointed out many times, the still relatively high risk premium and low valuations not only enable Hong Kong stocks to withstand certain external disturbances but also provide the possibility for market rebound under certain positive catalysts.

Chart: Financial data performance in January better than expected

Source: FactSet, Zhongjin Research Department

However, the current rebound still faces certain uncertainties:

1. The cooling of the market's expectations for a Fed rate cut has pushed up US bond yields, and there may still be variables and disturbances in the future;

2. Data monitored by EPFR shows that overseas active funds (a more accurate indicator of the actual movement of overseas funds) have not yet returned.During the Spring Festival, although there seems to be a relatively strong consumption recovery on the surface, there are certain structural differences and a situation of quantity increase and price decrease. For example, per capita spending on tourism and duty-free shopping has declined to varying degrees compared to the same period last year. In daily consumption, the fastest year-on-year growth in consumption is in areas below the fourth-tier cities, and there are significant differences in per capita tourism spending among different regions. Moreover, service consumption only accounts for 20% of the overall economy.

Therefore, further recovery in overall growth still requires more concrete evidence and policy support. We still believe that the core reason for the sustainability of the current rebound market is the targeted and robust fiscal policy, which is also the key to effectively addressing the credit tightening issue, the main challenge faced by China's short-term growth.

Chart: Uncertainties remain in the interest rate reduction path, with the 10-year US Treasury yield still hovering around 4%.

Source: Bloomberg, CICC Research Department

Source: Bloomberg, CICC Research Department

Chart: Overseas active funds have been continuously flowing out of the overseas Chinese stock market for the past 33 weeks.

Source: EPFR, Wind, CICC Research Department

Looking ahead, the key focal points worth paying attention to include whether the MLF and LPR will be lowered in February, policy signals from the two sessions in early March, and the minutes of the FOMC meeting on February 22. In the current market environment, we recommend that investors focus on the short-term rebound opportunities brought about by the "policy bottoming-out expectations", but in the medium term, unless there are substantial and large-scale policy implementations in finance and real estate, high dividends and a "dumbbell" allocation strategy will remain effective.

Specifically, the main logic supporting our above views and the key changes to focus on last week include:

1. The US CPI in January significantly exceeded expectations. Specifically, the CPI in January increased by 0.31% month-on-month, compared to the market consensus of 0.2%; and increased by 3.09% year-on-year, compared to the market consensus of 2.9%. The core CPI increased by 0.39% month-on-month, compared to the market consensus of 0.3%; and increased by 3.86% year-on-year, compared to the market consensus of 3.7%. The main differences in this unexpected result are: 1) underestimation of energy and food prices in overall inflation; 2) in core inflation, rents rose instead of falling, and other service prices such as medical, hotel, and airfare prices were generally higher.The comprehensive data this time exceeded expectations, giving the Federal Reserve and the market more reasons to believe that a rate cut in March is too early.

2) US retail sales in January were significantly lower than expected. Retail sales in January fell by 0.8% MoM, lower than the expected -0.2% and the previous value of 0.6%; excluding motor vehicles, retail sales fell by 0.6% MoM, lower than the expected 0.2% and the previous value of 0.4%. Although the average growth rate of core consumption for the two months of December and January remains positive, the unexpected cooling in January helps offset the pressure from higher-than-expected inflation.

3) MSCI announced the results of the quarterly index review for February 2024 on February 13th. Specifically, MSCI China Index included 5 new constituent stocks. Among them, 1 Hong Kong stock was included, which is BeiGene. 4 A-share stocks were newly included, namely Midea Group, Sananbio, CCCC Highway, and Huada Zhizao. At the same time, MSCI China Index removed 66 constituent stocks, including 14 Hong Kong stocks (such as China Soft Power International, Everbright Environment, and Sansei Pharmaceutical), 48 A-shares (including Shunluo Electronics, Sinopec Shanghai, and Huaxi Securities), and 4 Chinese concept stocks (Huanju, Daqo New Energy, Weibo, and Lufax Holding). After the adjustment, the number of constituent stocks in the MSCI China Index decreased from 765 to 704 (519 A-shares, weighting 17.2%; 168 Hong Kong stocks, weighting 73.5%; 14 Chinese concept stocks, weighting 9.0%; 3 B-shares, weighting 0.3%).

4) Hang Seng Index Company announced the results of the fourth quarter adjustment for 2023 on February 16th. The Hang Seng China Enterprises Index added China Unicom and removed China High Speed Transmission Equipment Group; the Hang Seng Tech Index added Tongcheng-Elong and removed Wisesoft; the number of constituent stocks in the Hang Seng Composite Index decreased from 518 to 514, adding 25 stocks including Shangao Holdings, Shimao Group, and Rui Pujun, and removing 29 stocks including Yuefeng Environmental Protection, Jituzu Express, and Guoquan Food.

03 Allocation Suggestions

The expectation of policy support may drive a short-term market rebound, and investors can adopt a "buy low" strategy. However, until more positive policies are implemented, we believe that the overall barbell allocation strategy is still effective in the current environment. Stable cash flow sectors (high dividend ratio, such as telecommunications, utilities, and energy), high-end technology upgrade sectors (technology hardware, semiconductors), and mid-range advantageous industries going global (engineering machinery, automotive and parts, new energy and photovoltaics, some brand consumption, etc.) will be the three main focus areas.

04 Key Events to Watch

China's MLF and LPR interest rates will be announced on February 18th and February 20th respectively; the National People's Congress will convene at the beginning of March.