What kind of policies does the market expect?

Abstract

The Hong Kong stock market stabilized and rebounded for two consecutive weeks after a significant pullback in mid-November, with the Hang Seng Index approaching the 20,000-point mark again. The recent recovery is not solely due to the calendar effect before important meetings, but more so due to improved expectations regarding trading policies. Therefore, policies are crucial for how the market will choose its direction moving forward. So, what kind of policies is the market expecting?

The root of the current issue lies in credit contraction. Addressing this problem requires reducing actual financing costs and boosting investment return expectations. Market expectations are also focused on these two aspects; although the direction is clear, the scale is even more important. On one hand, investors expect the central bank to further lower the reserve requirement ratio and interest rates. We estimate that the 5-year Loan Prime Rate (LPR) needs to be further reduced by 40-60 basis points, but is constrained by interest rate spreads, exchange rates, and other factors. On the other hand, investors are particularly focused on the overall tone of the Central Economic Work Conference regarding next year's fiscal policy strength. The market expects the official budget deficit ratio to be raised to above 3%, potentially reaching 3.5-4%. Additionally, with the 2 trillion yuan (6 trillion yuan over 3 years) already arranged by the Standing Committee of the National People's Congress, the new scale of broad fiscal expenditure is approximately 3 trillion yuan. However, we estimate that a one-time increase of 7-8 trillion yuan in fiscal expenditure is needed to fundamentally resolve the aforementioned issues. At the same time, the "real constraints" of high leverage, interest rates, and exchange rates may also imply that while there will be incremental stimulus, fulfilling overly high expectations may be quite difficult unless external pressures increase.

External uncertainties remain unresolved. Compared to 2016, the pace of policy rollout after Trump took office may be faster, with growth policies (such as tax cuts) potentially stronger than inflation policies (tariffs and immigration). For the Chinese market, the key issue is tariff policy. Under the assumption of moderate and limited domestic policy strength, if tariffs are implemented gradually, the expected impact on the market will be limited, and it is recommended to maintain a fluctuating structural operation. If a maximum tariff of 60% is imposed, the market may face significant disturbances, but this could provide better buying opportunities, i.e., opportunities arising from declines. However, aside from the uncertainties of Trump's trade policies, the recent warming expectations of Federal Reserve interest rate cuts may reduce disturbances to the Hong Kong stock market.

Under the assumption of moderate and limited domestic policy strength, the current fluctuating structure remains the baseline scenario. If significant volatility arises due to disturbances such as tariffs, it could provide better buying opportunities. Conversely, if domestic policies exceed expectations, it may intermittently push the market higher, but from a long-term "real constraint" perspective, we suggest that investors may take profits and shift towards structural investments at this time.

Main Text

What kind of policies is the market expecting?

Market Trend Review

The Hong Kong stock market rebounded slightly last week, with positive expectations regarding domestic policies remaining the main support. In terms of indices, the Hang Seng China Enterprises Index, MSCI China, and the Hang Seng Index rose by 2.7%, 2.7%, and 2.3% respectively, while the Hang Seng Tech Index increased by 2.6%. Sector-wise, insurance (+4.4%), energy (+4.2%), telecommunications services (+4.2%), and banking (+4.2%) led the gains, while healthcare (+0.6%), consumer staples (+0.9%), and materials (+1.2%) lagged behind Chart: Last week, the MSCI China Index rose by 2.7%, with the insurance, energy, and telecommunications services sectors leading the gains.

Source: FactSet, CICC Research Department

Market Outlook

As the economic work conference and the Politburo meeting approach, market expectations for domestic policy are warming up. Coupled with factors such as the decline in U.S. Treasury yields from high levels, the Hong Kong stock market has stabilized and rebounded for two consecutive weeks after a significant pullback in mid-November, with the Hang Seng Index once again approaching the 20,000-point mark. The recent recovery is also reflected in technical indicators: 1) The short interest as a percentage of the 5-day moving average has significantly dropped from a high of 17.3% to 14.6%, a new low since mid-November; 2) The 14-day Relative Strength Index (RSI) has quickly risen from a previous low of 37.2 to 51.8 within two weeks; 3) The risk premium has also fallen from a high of 7.85% to 7.57%.

Chart: The proportion of short selling in Hong Kong stocks has rapidly dropped to 14.6%

Source: Bloomberg, CICC Research Department

Chart: The risk premium of the Hang Seng Index has quickly fallen from 7.85% to 7.57%

Source: Bloomberg, CICC Research Department

The recent recovery is not solely due to the calendar effect before important meetings. Reviewing the performance before past Central Economic Work Conferences and December Politburo meetings, the Hang Seng Index has shown both gains and losses without a consistent pattern. Therefore, the current market is more about trading on expectations of policy improvement, and the trend after the meetings will depend more on whether the meeting content meets investor expectations. The recent trend has once again validated our previous judgment. Two weeks ago, we pointed out that the oscillating pattern remains the baseline assumption, but there is no need to be overly pessimistic; 19,000 is a key support level. Last week, we also mentioned that the short-term market is stuck at this position, which could go either way Chart: The Hang Seng Index has fluctuated before previous Central Economic Work Conferences

Source: Wind, China International Capital Corporation Research Department

Chart: The Hang Seng Index also shows mixed performance before previous December Politburo meetings

Source: Wind, China International Capital Corporation Research Department

As we approach important policy windows, and with the market having consolidated for a month, it is evident that policy will be crucial for the market's direction moving forward. So, what kind of policies is the market expecting?

The current issues of declining demand, low inflation, and weak credit, which in turn lead to poor profitability, are all rooted in credit contraction. This means that the financing costs faced by the private sector are generally higher than expected returns, resulting in continued "de-leveraging." We believe that addressing this issue requires lowering actual financing costs and boosting investment return expectations. The policy shift at the end of September aimed to reduce actual financing costs through interest rate cuts and reserve requirement ratio reductions, while stabilizing stock market prices through the establishment of swap convenience tools and stock buybacks, explicitly proposing to stabilize real estate prices, and increasing the counter-cyclical adjustment of fiscal policy to boost investment return expectations. Since September, the broad fiscal deficit pulse has significantly rebounded for two consecutive months, with fiscal spending boosting short-term growth, leading to China's manufacturing PMI remaining in the expansion zone for two consecutive months, and the stock market also rebounding significantly, showing clear effects. The real estate market is similar, with new home transaction areas in 30 cities and second-hand home transaction areas in 14 cities maintaining double-digit growth year-on-year. The economic and financial data to be released in the next two weeks will continue to verify the effectiveness and sustainability of the policies. We expect that areas directly affected by the policies will see recovery, such as the old-for-new policy or continued stimulation of retail sales growth, although the impact of the "Double Eleven" promotional activities may lead to a lower growth rate compared to October. However, areas with strong inertia, such as inflation and real estate investment, which are not directly benefiting from specific policy support, may still remain weak, and the acceleration of local debt replacement may also lead to lower credit growth.

Chart: Second-hand home transaction areas in 14 cities are rising

![](https://mmbiz-qpic.wscn.net/sz_mmbiz_png/ShbYhKZw7ia81hdojMkibN7jaZe3UKQ8gBLhBycldVa0peDd8NJyPIPbKBQUN5gs0AmaAuLrfMt4AyuCFqAjRMjg/640? Data source: Wind, China International Capital Corporation Research Department

Current market expectations are also focused on reducing actual financing costs and boosting investment return expectations. Although the direction is clear, the scale is more important. On one hand, investors expect the central bank to further lower the reserve requirement ratio and interest rates. Our calculations suggest that a further reduction of 40-60 basis points in the 5-year LPR could eliminate the inversion of financing costs and investment returns. However, constraints such as bank spreads and the RMB exchange rate will limit the actual space and effectiveness that the central bank can operate in the short term.

On the other hand, investors are paying close attention to the overall tone of the Central Economic Work Conference regarding next year's fiscal policy strength. However, specific figures will need to wait for the government work report to be released at next year's Two Sessions. The market expects an increase in the general public budget deficit ratio and further strengthening of consumption stimulus. The market anticipates that the official budget deficit ratio will be raised to above 3%, possibly reaching 3.5-4%. In addition, the 2 trillion yuan (6 trillion yuan over 3 years) already arranged by the Standing Committee of the National People's Congress[1] suggests that the new scale of broad fiscal expenditure will be about 3 trillion yuan. However, we estimate that a one-time increase of 7-8 trillion yuan in fiscal expenditure is needed to address the aforementioned issues. Meanwhile, high leverage, interest rates, and exchange rate "real constraints" may also mean that while there will be incremental stimulus, fulfilling overly high expectations may be quite difficult unless external pressures increase.

External uncertainties remain unresolved. Last week, the U.S. added 136 Chinese companies to the entity list[2], which has made the market pay more attention to the timing and pace of Trump's subsequent policies.

1. In terms of timing, after Trump takes office on January 20, he may quickly introduce some inflationary policies, including immigration and tariffs. At that time, attention can be paid to his policy priorities. The State of the Union address and the new budget proposal in February-March will provide clearer directions for fiscal expenditure cuts. Overall, compared to 2016, the speed of policy rollout after Trump takes office may be faster. However, in the current inflationary environment, to ensure that he does not lose control of Congress due to inflation before the 2026 midterm elections, growth policies (such as tax cuts) may be a more appropriate strategy than inflation policies (tariffs and immigration).

2. In terms of specific policies, for the Chinese market, the key issue is tariff policy. Assuming that domestic policy strength is moderate and limited, if tariffs are implemented gradually, such as an initial tariff of 30-40%, which means an additional 10-20% on the current level of 19%, we expect limited market impact and recommend that investors maintain current oscillating structural operations. If the maximum tariff is raised to 60%, due to insufficient market pricing and the actual impact becoming non-linear, the market may face significant disturbances, but this could provide better buying opportunities. After all, compared to the current "stagnant" level, sufficiently cheap buying points can also hedge against risk disturbances, that is, opportunities that arise from declines.

However, aside from the uncertainties of Trump’s dealings, the rising expectations of Fed rate cuts can reduce disturbances to Hong Kong stocks. The U.S. unemployment rate rose in November, and the labor participation rate declined, pushing U.S. Treasury yields slightly lower to 4.17%, with December rate cut expectations rising to over 90% Based on the above analysis, under the assumption of moderate and limited domestic policy strength, the current oscillating structure remains the baseline scenario. If significant fluctuations occur due to disturbances such as tariffs, it could provide better buying opportunities. Conversely, domestic policies exceeding expectations may intermittently push the market higher, but from a long-term "realistic constraint" perspective, we suggest that investors can take profits and shift towards structural investments at this time. We recommend that investors focus on the following in the coming weeks: the economic work conference and Politburo meeting at the end of December, and the priorities for policy advancement after Trump takes office in early January, especially the speed and intensity of tariff policies.

In terms of allocation, under the assumption of an overall oscillating pattern, we suggest focusing on three types of industries: first, sectors where supply and policy environments are fully cleared, and if there is still marginal demand improvement, it would be even better, such as certain consumer services in the internet sector, home appliances, textiles and apparel, and electronics. Second, policy-supported directions, such as home appliances and automobiles under the old-for-new policy, as well as trends in self-reliant technology fields like computers and semiconductors; third, stable returns, such as high dividends from state-owned enterprises.

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

1. The central bank announced that starting January 2025, it will revise the M1 statistical caliber to include personal demand deposits and customer reserve funds from non-bank payment institutions. After the revision, M1 will be included in the statistical scope based on the current circulating currency M0 and unit demand deposits, incorporating personal demand deposits and customer reserve funds from non-bank payment institutions. The market has anticipated the adjustment of the M1 statistical caliber. After the adjustment, the year-on-year decline of M1 will narrow, as household demand deposits are relatively stable, and the year-on-year growth rate of M1 will also smooth out, but the rebound in the year-on-year growth rate of M1 still depends on the improvement of corporate profits and increased fiscal spending.

2. The U.S. ISM Manufacturing PMI for November remains in the contraction zone, and the ISM Non-Manufacturing PMI fell short of expectations. The U.S. Manufacturing PMI for November is 48.4, an increase of 1.9ppt from the previous month, better than expected, but still in the contraction zone. In terms of components, the new orders index has significantly risen, reaching above 50, returning to the expansion area, and the production index and employment index have also rebounded. The U.S. Non-Manufacturing PMI for November is 52.1, below the expected 55.5, with slower expansion, and the indices for business activity, new orders, employment, and supplier deliveries are all relatively weak.

3. The U.S. non-farm data for November is better than expected, but the unemployment rate has risen, and the labor participation rate has slightly declined. The U.S. non-farm payrolls increased by 227,000 in November, with wage growth year-on-year increasing by 4% and month-on-month by 0.4%, both better than expected. However, the unemployment rate rose from 4.15% in October to 4.25%, and the labor participation rate slightly declined to 62.5%. The October non-farm data was less affected by extreme weather, and this month's improvement is a return to normal. The market is more focused on the rising unemployment rate rather than the increase in non-farm payrolls. After the data was released, U.S. Treasury yields slightly fell to 4.17%, with the expectation of a rate cut by the Federal Reserve in December rising to over 90%. A rate cut in December remains a high probability event, with the Federal Reserve having room for 3-4 rate cuts, corresponding to an endpoint of 3.5-3.75%, and the long-end U.S. Treasury yield center at 3.8-4%

4. Overseas active funds continue to flow out of the Chinese market, while passive funds have turned to inflow, and southbound capital inflow has slowed. EPFR data shows that as of December 4, overseas active funds' outflow from the Chinese stock market narrowed to USD 250 million (vs. USD 580 million outflow in the previous week), marking eight consecutive weeks of outflow. Overseas passive funds turned to inflow of USD 460 million after five consecutive weeks of outflow (vs. USD 550 million outflow in the previous week). Meanwhile, southbound capital inflow remained basically flat compared to the previous week, slowing slightly from an inflow of HKD 28.33 billion to HKD 24.43 billion.

Chart: Overseas active foreign capital continues to flow out, while passive foreign capital turns to inflow

Source: EPFR, Wind, China International Capital Corporation Research Department

Author of this article: CICC Liu Gang Team, Source: Kevin Strategy Research, Original Title: "CICC | Hong Kong Stocks: What Kind of Policy Does the Market Expect?"

Analyst Liu Gang CFA SAC Practicing Certificate No.: S0080512030003 SFC CE Ref: AVH867

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