Hong Kong stocks in the second half of the year: Valuations are very attractive, but liquidity is lacking, focusing on three main themes.

Source: Wang Yihan, CITIC Securities

Due to external risks, Hong Kong stocks have significantly underperformed US stocks since the beginning of the year, with thematic trading dominating the performance of the two markets.

Currently, Hong Kong stocks have already priced in pessimistic expectations, and performance and valuation are still attractive.

However, since 2021, the continuous outflow of long-term foreign capital has led to a shrinking trading volume and an increase in short selling behavior in Hong Kong stocks, with multiple biased trading funds continuing to play games.

Considering the potential overseas risks in the second half of the year, it is judged that the current gaming environment will continue, and it is recommended that investors focus on long-term high-certainty directions with performance support and policy catalysis.

Hong Kong stocks are highly attractive

The current valuation level of Hong Kong's main indexes is extremely attractive.

The dynamic PEs of the Hang Seng Composite Index and the Hang Seng TECH Index are 9.3 times and 22.8 times, respectively, both below one standard deviation of the historical average.

Since May, the expected growth rate of Hong Kong stock performance has bottomed out and rebounded, and the "performance bottom" has appeared. The expected net profit and revenue growth rates of the Hang Seng Composite Index in 2023 are 18.8% and 8.3%, respectively.

In addition, from the perspective of the trend of actual profit growth rate, the Hang Seng Index EPS growth rate has also bottomed out in the third and fourth quarters of 2022.

The expected EPS growth rate in the future is expected to trend upwards, and the fundamentals of Hong Kong stocks are supported.

Foreign capital outflows have reached a historical high, and the trend of capital games may continue

Since the beginning of the year, foreign capital has flowed out of Hong Kong stocks by more than HKD 140 billion. Since 2021, foreign capital has flowed out of Hong Kong stocks by a total of HKD 1.05 trillion.

At the same time, the pressure on investor sentiment has led to a decline in Hong Kong stocks with shrinking trading volume. The average monthly turnover has fallen from HKD 136 billion before this year's Spring Festival to HKD 97 billion, which is far lower than the level of around HKD 250 billion at the beginning of 2021.

In terms of short selling, the short selling ratio of Hong Kong stocks has rebounded to 24.4%, which is close to the level of two standard deviations above the historical average.

In terms of trends, the short selling ratio has also continued to rise since the beginning of 2021, reflecting the environment in which various biased trading funds, including hedge funds, continue to play games in the absence of long-term foreign capital.

Therefore, before long-term capital inflows return, the overall liquidity and investment environment of Hong Kong stocks will be under pressure.

Hong Kong stock allocation advice

Focus on three main lines with long-term high certainty supported by performance and policy catalysis.

Looking forward to the second half of the year, although the valuation and performance advantages of Hong Kong stocks are still significant, the game of various types of trading-oriented funds is expected to continue in the absence of long-term foreign capital.

Therefore, it is recommended that investors focus on the long-term high certainty direction supported by performance and policy catalysis, and focus on three long-term main lines:

1. Domestic demand-driven: In the second half of the year and even in 2024, the domestic fundamentals will continue to recover, and the short-term relative benefits will be in the travel industry chain; in the medium and long term, the repair of residents' asset-liability ratios, the rebound of consumer confidence, and the recovery of large durable goods consumption will be beneficial;

2. Interest rate-sensitive industries: In the second half of the year, potential overseas financial system risks may force the Federal Reserve to reverse monetary tightening, and the expectation of liquidity difference will benefit the valuation repair of interest rate-sensitive industries, including the Internet, biotechnology, and EV;

3. "Mid-to-low valuation" trading may run through the year, and subsequent attention will be paid to undervalued, policy-catalyzed industries and targets with excellent operating indicators.