The logic behind the rebound and style shift in the Hong Kong stock market

Abstract

Since early August, the Hong Kong stock market has risen for four consecutive weeks. We have been emphasizing that the Hong Kong stock market has shown greater resilience compared to the A-share market. However, this week's market also reflected some changes: on one hand, the market's gains expanded, while on the other hand, there was a clear shift in sector rotation. Banking stocks, which had surged earlier, experienced significant declines on Thursday and Friday, while growth stocks, insurance, essential consumer goods, and real estate sectors surged. In addition, the recent continuous strengthening of the Renminbi has raised investors' concerns about whether the market will undergo a "turning point."

In the short term, due to interest rate cuts and policy expectations, the Hong Kong stock market may still exhibit better resilience than the A-share market. Recent marginal changes have occurred within the Sino-US credit cycle framework, which, if sustained, could provide further support. In the first quarter, the Sino-US credit cycle resonated in "short waves" based on fiscal and private sectors, leading to a second-quarter rally in the U.S. real estate chain, export chain, and pro-cyclical market. The current situation seems to have certain conditions for a similar scenario. The expected interest rate cut in September is likely to provide liquidity support and also create a window for domestic policy easing. We anticipate that fiscal policy in the third quarter will be more proactive than in the second quarter. If this materializes, short-term focus can be on small cycles and short waves.

However, short-term market opportunities do not imply a trend reversal. In the medium to long term, the decisive factors for the trends in the A-share and Hong Kong stock markets still lie in whether domestic fundamentals and policies can make greater progress. In the current situation, although there may be marginal improvements in policies in the third quarter, the focus for the year may be on implementing existing policies. The Ministry of Finance has recently emphasized "firmly preventing the introduction of policies that exceed fiscal capacity and new projects." Although the internal economic growth momentum remains weak, the expectation of "strong stimulus" is still unrealistic.

On the allocation strategy front, as the Fed's interest rate cut approaches, we continue to emphasize that the Hong Kong stock market has greater resilience than the A-share market. In the short term, under the interest rate cut trade, growth sectors benefiting from the denominator logic may have higher resilience. However, overall, until greater fiscal support is seen, the structural market with wide-ranging fluctuations remains the main theme.

Market Review

This week, the Hong Kong stock market continued to rise and outperformed A-shares again, with net inflows returning from the southbound funds. The Hang Seng Tech Index rose by 2.6%, the Hang Seng Index by 2.1%, Hang Seng State-Owned Enterprises by 1.8%, and the MSCI China Index fell slightly by 0.4%. In terms of sectors, insurance (+5.2%), essential consumer goods (+3.4%), and energy (+3.1%) were the top gainers, while banking (-4.1%) and discretionary consumer goods (-2.6%) were the top losers.

Chart: Insurance and essential consumer goods lead the gains, while banking and discretionary consumer goods lead the losses

Market Outlook

Since early August, the Hong Kong stock market has risen for four consecutive weeks, showing a trend independent of A-shares. Our view that the Hong Kong stock market has greater resilience compared to A-shares has once again been validated. However, behind the continued rebound, this week's market also showed some different changes: on one hand, the market's gains expanded, while on the other hand, there was a clear shift in sector rotation. Banking stocks, which had surged earlier, experienced significant declines on Thursday and Friday, growth styles, insurance,The surge in sectors such as consumer staples and real estate is somewhat related to the market's expectation of further lowering existing home loan rates and switching to mortgages over the weekend. Coupled with the recent continuous strengthening of the Renminbi, it has raised investors' concerns about whether the market will undergo a "turning point."

However, whether it's a market rebound or style rotation, investors still have doubts, as the "flash in the pan" market has appeared many times, even the unexpected surge in April-May ultimately ended up retracing half of the gains. Moreover, after four consecutive weeks of gains, several technical indicators have significantly recovered, such as the Hang Seng Index risk premium dropping to 8.6%, the lowest since late July, short interest falling to 16%, and RSI indicating the market is overbought. We believe that in the short term, interest rate trading and policy expectations may present opportunities in the market, but in the medium to long term, the key to determining the trend of the Chinese market, including Hong Kong stocks, still lies in whether domestic policies can make greater progress.

Chart: Hang Seng Index risk premium rises to 8.6%, the lowest since late July

Chart: Relative Strength Index (RSI) shows Hong Kong stocks nearing overbought levels

To judge the future trend of the market, we must first clarify the reasons for the significant rebound in Hong Kong stocks and style rotation this week:

1) Since the end of July, the expectation of interest rate cuts has increased, the continuous weakening of the US dollar, combined with factors such as the release of exporters' foreign exchange demand [1], US-China relations, and strengthening domestic policy expectations, have collectively supported the strengthening of the Renminbi. Last week, the USD/CNH exchange rate broke through the 7.10 level, and the Renminbi appreciated to a high point not seen in nearly 15 months, all of which have become factors supporting the performance of Hong Kong stocks.

2) Expectations for new round of policy support are rising, with fiscal strength measured by the fiscal deficit pulse since July increasing marginally. In addition, Bloomberg reported on August 30 that there may be further lowering of existing home loan rates domestically [2]. At the end of August 2023, the People's Bank of China and the China Banking and Insurance Regulatory Commission proposed lowering the interest rate on existing first-home loans to the "lower limit of the city's interest rate at the time of loan issuance" starting from the end of September [3], but the impact on cities with higher lower limits like Beijing is limited. Of note in this news is the possibility of allowing existing home loans to seek mortgage transfers. If realized, we expect the current approximately 4% existing home loan rate to be lowered by 60 basis points to the new rate (3.4%), greater than the 35 basis points reduction in existing home loan rates on the repricing date in January next year (the reduction within the year of the 5-year LPR), which is expected to reduce household debt burden, boost consumption, and alleviate the trend of residents actively deleveraging.

3) The market style has recently switched from bank stocks to insurance, real estate, and consumer staples sectors, partly due to the overreaction of bank stocks after a rapid unilateral rise, and partly related to the aforementioned policy expectationsChart: Recent decline in US bond yields, RMB strengthening

In addition, the profit growth rate in the Hong Kong stock market in the second quarter may boost compared to the first quarter, with some targets such as Meituan, Ctrip, China Life, Anta Sports showing impressive performance, providing support to the recent market. The profit of Hong Kong stocks in the first half of 2024 is expected to increase by about 6% year-on-year, an improvement from -2% in the first quarter, with the utilities and communication services sectors leading in profit growth, while the real estate and information technology sectors experiencing a decline in profit. Compared to A-shares, Hong Kong stocks have a more advantageous profit structure, with the well-performing internet sector being a major sector in Hong Kong stocks. In the second quarter, the media and entertainment sector saw double-digit profit growth, while the midstream manufacturing industry, which has a large proportion in A-shares, is generally under pressure due to current oversupply and price pressures.

Chart: Hang Seng Index market expects a 10.6% profit growth in 2024

Therefore, under the short-term interest rate cuts and policy expectations, Hong Kong stocks may still have better resilience than A-shares. Recent marginal changes have occurred in the Sino-US credit cycle framework, which could provide more support if sustained. In the US, the US bond yield has dropped to 3.8%, returning to the level in January this year, driving improvements in US existing and new home sales in July, similar to the situation in the previous 2-3 months, which may accelerate US residents' mortgages, achieving "credit expansion" in the private sector. In China, the fiscal deficit impulse in July and the marginal improvement in social financing bond issuance have slightly accelerated year-on-year, similar to the fourth quarter of last year. If mortgage conversions are realized, it can also address some of the cost repayment and consumption capacity issues. In the first quarter, the Sino-US credit cycle resonated in "small waves" based on fiscal and private sector, promoting the first and second quarter rallies in the US real estate chain, export chain, and pro-cyclical market. Currently, there seems to be certain conditions for "resonance," with the September Fed rate cut "on the table," expected to provide liquidity support, help repair marginal US real estate demand, and also provide a window for domestic policy easing. In addition, we expect fiscal policy in the third quarter to be more proactive than the second quarter in terms of contraction. If realized, short-term attention can be focused on small cycles and small wave operations.

Chart: Marginal improvement in July fiscal deficit impulse

However, short-term market opportunities do not imply a trend reversal. In the medium to long term, the decisive factors for the trends in A-shares and Hong Kong stocks still depend on whether domestic fundamentals and policies can make greater progress. In the current situation, although there may be marginal improvements in the third quarter at the policy level, the focus for the year may be on implementing existing policies, with the Ministry of Finance recently emphasizing "firmly preventing the introduction of policies beyond fiscal capacity, new projects," thus, the expectation of "strong stimulus" remains unrealistic.Currently, the endogenous driving force of economic growth remains weak. In August, the manufacturing PMI was 49.1%, a decrease of 0.3 percentage points from the previous month, while the service PMI was 50.2%, an increase of 0.2 percentage points from the previous month. Recent high-frequency macroeconomic data shows: 1) Weak consumption trend: During the summer travel peak season, China Railway Group reported that during the summer travel period (August 1st to August 25th), the national railway sent a total of 802 million passengers, a year-on-year increase of 6.2%[5]. However, Ctrip's report shows that airfare and hotel prices are decreasing, and less popular destinations are favored[6]. Service-oriented consumption pursues cost-effectiveness, with retail and wholesale sales of passenger cars declining year-on-year in the first four weeks of August, and sales of durable goods remaining weak; 2) Real estate volume and price remain weak: In the week of August 23rd, the transaction area of commercial housing in 30 cities dropped by more than 20% year-on-year, and the index of listing prices for second-hand houses continued to weaken; 3) Exports are relatively stable but may weaken in the second half of the year: Container throughput at ports remains at a high level, but freight rates have been continuously falling recently, indicating a possible weakening of exports on a month-on-month basis in the second half of the year. With insufficient credit demand, financial data for August may also be weak.

In terms of allocation strategy, as the Fed's interest rate cut approaches, we still suggest that Hong Kong stocks have greater flexibility than A-shares. In the short term, under the trading of interest rate cuts, growth sectors benefiting from the denominator logic may have higher flexibility, such as semiconductors, automobiles (including new energy vehicles), media and entertainment, software, biotechnology, etc. However, overall, until we see greater fiscal support, a structural market with wide-ranging fluctuations remains the main theme. In summary, the 10-year U.S. bond yield falling to 3.8% has already priced in the interest rate cut expectations to a large extent. If the risk premium returns to the level of last year, the Hang Seng Index would be around 19,000; if profits grow by 10% on this basis, the corresponding level for the Hang Seng Index would be 21,000. We continue to recommend three directions in the outlook for the second half of the year under the structural market: overall return decline (stable returns from high dividends and high buybacks, i.e., "cash cows" with ample cash flow; short-term dividends may see differentiation between local dividends, low-volatility dividends, and cyclical dividends), partial leverage (industries with certain business cycles or benefiting from policy-supported technological growth), partial price increase (natural monopoly sectors, utilities, etc.).

Chart: If the risk premium returns to the level of last year, the Hang Seng Index would be around 19,000; if profits grow by 10%, the corresponding level would be 21,000

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

1) The month-on-month decline in China's manufacturing PMI in August, which continues to remain in the contraction zone. The manufacturing PMI in August was 49.1%, a decrease of 0.3 percentage points from the previous month, indicating a slight decline in the manufacturing business climate. The production index, new orders index, and raw material inventory index all decreased by 0.3, 0.4, and 0.2 percentage points respectively compared to the previous month, all remaining in the contraction zone, showing a decline in production activities, market demand, major raw material inventories of manufacturing enterprises, and a decrease in labor demandRaw material suppliers have extended delivery times. The non-manufacturing PMI in August was 50.3%, up 0.1ppt from the previous month, mainly driven by a 0.2ppt increase in the service industry PMI, while the construction industry PMI decreased by 0.6ppt month-on-month. Overall, the comprehensive PMI in August was 50.1%, a decrease of 0.1ppt from the previous month.

Chart: The manufacturing PMI in August was 49.1%, down 0.3ppt from the previous month.

Chart: Production and order items of the manufacturing PMI in August decreased month-on-month.

2) From January to July, the year-on-year growth of profits of industrial enterprises above designated size in China was 3.6%, accelerating by 0.1ppt compared to January to June. From January to July, the year-on-year growth of operating income of industrial enterprises was 2.9%, consistent with the growth rate from January to June; operating costs increased by 3.0% year-on-year; the operating income profit margin was 5.40%, an increase of 0.04ppt year-on-year. In July, industrial enterprises above designated size achieved a year-on-year profit growth of 4.1%, accelerating by 0.5ppt compared to June, marking the second consecutive month of acceleration. This was mainly supported by a slight improvement in profit margins, while overall revenue remained stable due to weak demand. Among the 41 major industrial categories, the profit growth rates of 21 industries accelerated or narrowed compared to the previous month. The mining industry saw a decline in profit growth rate, while the manufacturing and public utility industries saw a slight increase in profit growth rate [8].

3) In July, China's fiscal deficit showed marginal improvement. From January to July, the year-on-year decrease in national general public budget revenue was 2.6%, but after excluding the impact of special factors, it grew by around 1.2% on a comparable basis; national general public budget expenditure increased by 2.5% year-on-year. From January to July, national government fund budget revenue decreased by 18.5% year-on-year, while expenditure decreased by 16.1% year-on-year. From January to July, the deficit in the general public budget and government fund budget increased by 0.5 trillion yuan year-on-year [3]. In July, there was a marginal improvement in the fiscal deficit, with general fiscal revenue declining by 8.3% year-on-year, lower than the 8.5% decline in June, while general fiscal expenditure increased by 3.7% year-on-year, turning positive from -4.9% in June. The general fiscal deficit increased by 295.7 billion yuan year-on-year, widening compared to the previous month.

4) The State Administration for Market Regulation announced that Alibaba has completed a three-year rectification. The State Administration for Market Regulation stated in the announcement that Alibaba has strictly regulated its own business operations, conscientiously implemented platform main body responsibilities, improved corporate compliance management systems, enhanced the service levels of platform merchants and consumers, and achieved good results in compliance rectification [10].

5) This week, southbound funds resumed inflows, while overseas active funds continued to flow out. Specifically, data from EPFR shows that this week, overseas active funds continued to flow out of overseas Chinese A-share markets, with outflows of approximately $240 million, remaining relatively stable compared to the previous week, marking the 68th consecutive week of outflowsAt the same time, overseas passive funds continued to flow in with $170 million (compared to $70 million the previous week). Southbound funds resumed inflows this week, with a total inflow of HKD 5.03 billion, compared to an outflow of HKD 1.46 billion the previous week.

Chart: Continuous outflow of active funds from overseas Chinese stock markets

Key Events to Watch

• September 3: US ISM Manufacturing PMI
• September 6: US Non-Farm Payrolls Change
• September 9: China's August CPI and PPI.

[1] https://www.research.cicc.com/zh_CN/report?id=347930&entrance_source=ReportList

[2] https://www.bloomberg.com/news/articles/2024-08-30/china-mulls-allowing-refinancing-on-5-4-trillion-in-mortgages

[3] https://www.gov.cn/zhengce/zhengceku/202309/content_6901351.htm

[4] https://www.yicai.com/news/102253918.html

[5] https://www.gov.cn/yaowen/liebiao/202408/content_6970647.htm

[6] https://finance.eastmoney.com/news/1354,202408283168705511.html

[7] https://www.stats.gov.cn/sj/zxfb/202408/t20240831_1956161.html

[8] https://www.stats.gov.cn/sj/sjjd/202408/t20240827_1956107.html

[9] https://www.gov.cn/lianbo/bumen/202408/content_6970634.htm

[10] https://www.samr.gov.cn/xw/zj/art/2024/art_df43b84d3f9f4dc6ba9c99b4195b3770.htmlAnalyst Liu Gang CFA SAC Practitioner Certificate Number: S0080512030003 SFC CE Ref: AVH867

Contact Person Wang Muyao SAC Practitioner Certificate Number: S0080123060036

Analyst Zhang Weihan SAC Practitioner Certificate Number: S0080524010002 SFC CE Ref: BSV497

Analyst Wu Wei SAC Practitioner Certificate Number: S0080524070001