Pessimistic sentiment prevails. Where is the hope for Hong Kong stocks?

Source: Haitong Securities Xun Yugeng, Zheng Zixun, Wang Zhenghe

Since June, Hong Kong's Hang Seng Technology has led the way in terms of gains, and multiple indicators show that Hong Kong stocks are still in historically low territory and have long-term value for allocation.

With the end of the Fed's rate hikes, the pressure of overseas funds on Hong Kong stocks is expected to ease, and southbound funds continue to flow against the trend, which may become a support for Hong Kong stocks. With the recovery of the inventory cycle, the domestic economy and Hong Kong stock profits are expected to continue to recover.

Multiple indicators show that Hong Kong stocks are still in historically low territory

Although Hong Kong stocks have accumulated some gains since June, considering the deep adjustment they experienced earlier, Hong Kong stocks are still at historically low levels. Multiple indicators show that Hong Kong stocks still have a high investment value in the medium and long term.

Valuation:

As of September 15, 2023, the forward PE ratio of the Hang Seng Index is only 8.5 times, which is in the 1.3% percentile since 2013, indicating that Hong Kong stocks are significantly undervalued relative to the expected earnings growth in the next 12 months.

From the perspective of risk premium, the risk premium rate of the Hang Seng Index is currently 8.0%, significantly higher than the mean plus one standard deviation, ranking at the 91.8% percentile since 2013. This indicates that investors have a low risk preference for Hong Kong stocks.

From the perspective of the stock-bond ratio, Hong Kong stocks have a higher cost-effectiveness for domestic investors. However, due to the historically high US bond interest rates, the advantage of Hong Kong stocks in terms of the stock-bond ratio is not significant for overseas investors.

Trading:

Thin trading at market bottoms is an important characteristic, especially for Hong Kong stocks with relatively limited liquidity. As of September 15, 2023, the average daily turnover of Hong Kong stocks in the past 60 days has dropped to HKD 72.56 billion, a decrease of 62% from the peak at the beginning of 2021. The current level of market trading activity is consistent with historical market lows.

In addition, a unique feature of the Hong Kong stock market is the presence of a significant short-selling force. The short-selling turnover of Hong Kong stocks currently accounts for 17.1% of the total market turnover, with a 5-week average of 17.9%, significantly higher than the 15.0% average since 2016, and approaching the 20.3% at the market bottom in October 2001 and the 18.9% at the market bottom in 2018. This indicates that investors in the current Hong Kong stock market have a strong pessimistic sentiment.

Improvement expected in the capital situation of Hong Kong stocks

Due to the continuous appreciation of the US dollar and large outflows of foreign capital, the total balance of Hong Kong's basic currency has shrunk to a historically low level. The peak pressure of foreign capital outflows may have passed.

Southbound funds continue to flow into Hong Kong stocks, and are expected to continue to provide support for Hong Kong stocks.

Since 2022, southbound funds have been contrarian buying Hong Kong stocks. In terms of the targets bought, the strategy of southbound funds in allocating Hong Kong stocks this year is the "barbell strategy," which includes increasing positions in internet companies represented by Meituan, Kuaishou, and Tencent, as well as high dividend stocks represented by CNOOC, China Mobile, and Sinopec. Looking ahead, Southbound funds often start to layout before the bottom of the Hong Kong stock market. After that, they will continue to flow in as the market rises. This round of Southbound funds began to flow in on a large scale as early as the beginning of 22. Since the bottom of the Hong Kong stock market in October 22, the net inflow of Southbound funds has remained at around HKD 100 billion for three consecutive months, and the buying intensity is at a historically high level. It is expected to continue to support the rise of the Hong Kong stock market.

Fundamental recovery supports the trend of the Hong Kong stock market

Looking ahead, the inventory cycle in the third quarter may bottom out and rebound, and the domestic macroeconomy and the profitability of Hong Kong-listed companies are expected to improve.

According to Bloomberg data, the consensus expected EPS of the Hang Seng Index has bottomed out since July, and the consensus expected EPS of the Hang Seng Tech Index has started to rise.

In the future, the policy of stabilizing growth is still being continuously implemented. At the same time, China has experienced six complete inventory cycles since 2000, with an average duration of about 40 months. The duration of this inventory cycle has exceeded the average, and it is expected to bottom out and rebound in the third quarter, effectively promoting the recovery of the domestic economy.

Although the net profit growth rate of Hong Kong-listed companies in the first half of the year has declined, it is still in positive growth. The cumulative YoY growth rates of net profit attributable to shareholders of all Hong Kong-listed companies in H1 2023/2022 were 1.2%/3.0%, and it is expected that the profit growth rate of enterprises will stabilize and rebound in the third quarter.