Hong Kong stocks suddenly change their face, to escape or to accept?

Last week, after a period of vigorous rise since the beginning of this year, the Hong Kong stock market also began to give back gains, while the US stock market, after a slight increase, once again entered a period of volatility.

So, how should we view the investment opportunities in the Hong Kong and US stock markets next? Dolphin's strategy weekly report this week attempts to sort it out.

1. Confirmation of a Bottom Line: Fed Put

If the market was still concerned about the possibility of rate hikes earlier before May, at the May interest rate meeting, Federal Reserve Chairman Powell faced seemingly retaliatory inflation data, which basically reduced the probability of rate hikes to zero.

This also means that for the Federal Reserve, the real choice of interest rates is just a matter of when to start cutting: either no rate cuts this year, or 1-2 cuts, with the timing pushed back to November-December this year.

In other words, for the remaining time this year, short-term interest rates have been anchored, and the fluctuation space thereafter is likely to be very small. The around 4.7% yield on the ten-year Treasury bond tested in April is likely to be the high point for this year, and it will be quite difficult for rates to rise further.

Compared to the short-term interest rates being basically locked in and the high point of the ten-year Treasury bond roughly anchored, the downward space for the ten-year Treasury bond yield can still fluctuate based on actual economic data.

From the perspective of economic fundamentals, the good employment situation in the United States can still continue, the balance sheets of US residents are still very healthy, and the core CPI sub-items—whether it's rent or the average/median price of new homes—have already begun to hold up under high interest rates.

Therefore, for safety, when investing for the rest of the year, it is safer to expect 0-1 rate cuts for the US stock market this year.

In history, every time the US stock market truly started a trend of major decline, it was when EPS began to trend downward. Currently, there is no sign of deterioration in the US macroeconomic fundamentals, and with Powell and Yellen guarding the liquidity, it is difficult for liquidity to go wrong. It's just that with valuations reasonably high, attention should still be paid to the fluctuation opportunities in hot sectors in the US stock market this year, as well as the cross-industry and cross-market diffusion of investment opportunities.

The focus should still be on the opportunities in industries and sectors between two different economic paths (no landing and soft landing), such as growth represented by biopharmaceuticals, AI, and technology, and traditional cyclical sectors represented by aviation, chemicals, etc Of course, leading the seven gods of the US stock market last year, entering 2024, due to entering a new investment-output mismatch cycle, the expected EPS growth rate has slowed down. However, the overall EPS growth rate of the S&P 500 has not slowed down, but rather it is starting to be supplemented by cyclical industries (such as the traditional semiconductor cycle represented by memory and SMIC's recovery, as well as a slight acceleration in the advertising industry, etc.).

In other words, compared to the trend-driven rise of the seven gods of the US stock market last year, this year's seven major companies mainly present opportunities for stock price fluctuations: such as Google's undervaluation in the first half of this year, Tesla falling into the range below 150 for swing trading opportunities, and so on. To truly seek excess returns and high-yield space this year, opportunities should still be sought from assets and markets with significant repair elasticity.

II. Hong Kong stocks suddenly change face, should you run or catch?

At a time when global investors are searching for undervalued opportunities, Hong Kong stocks first continued to rise this year, but last week it seemed to lose momentum. Before answering whether to run or catch this time with Hong Kong stocks, it is necessary to first understand what is driving the rise of Hong Kong stocks this time. Let's first look at it from a fundamental perspective:

a. Improved external demand, export recovery

As China, as an export-oriented economy, starts an interest rate cut cycle overseas and global PMI bottoms up, net exports, one of the three major drivers of economic growth, have greater hopes for recovery on top of the low base of last year. The export data since the Chinese New Year has indeed been improving.

b. More proactive policy support

Compared to last year when there was insufficient understanding of the deflation trend domestically, and it was believed that retaliatory consumption would come after opening up, after a year of evolution, there is now a full understanding of the sluggish domestic demand and shrinking real estate sales. Therefore, policy follow-up can be more proactive.

In addition to the increase in the number of second-hand housing listings, continuous decline in house prices, and continuous shrinkage in new home sales, when companies like Vanke, joint ventures, start to show signs of default risk, the significant relaxation of real estate sales once again confirms that the government this year is more proactive in responding to the decline in demand.

c. Corporate governance improvement

At the individual stock level, there is a stronger emphasis on dividends and buybacks. Not only have many companies started to return value to shareholders, but the dividend payout ratio of some companies has also increased to a yield of 5-6% The above is the area where marginal improvement is needed. The areas where marginal deterioration still exists are the "three icebergs" - weak domestic demand (CPI hovering around deflation online), household deleveraging (early repayment, weak credit and social financing), and a contraction in the real estate sector.

In other words, this year's upward trend is similar in logic to last year's upward trend - both are based on extreme undervaluation, but with marginal improvement in valuation due to the current situation.

During last year's upward trend, the market was overly optimistic and did not realize the difficulties of post-pandemic recovery. In reality, there was a collective household deleveraging, excessive repair of government balance sheets, and a failure to timely counter the downward trend in the economy. Ultimately, the optimistic market logic was refuted, and the stock market instead fell to new lows.

Since the beginning of 2023, the current Hong Kong stock market has rebounded from the valuation percentile of nearly five years to 40%. In the peripheral US dollar markets that Dolphin Jun pays attention to, the gains in the Japanese and German stock markets are almost on par. However, from the current market valuation perspective, compared to overseas assets with a PE ratio of over 15 times, Hong Kong stocks are still around 10 times, indicating a certain valuation discount.

But Dolphin Jun believes that it is not appropriate to buy in the short term during this period of Hong Kong stock market correction, especially for assets with weaker fundamentals. Overall, this year, as funds have become more rational during the valuation repair process, coupled with some recent shady operations in the process of Chinese asset repurchases overseas (which Dolphin Jun will analyze separately in the near future), funds are not willing to price in too much repair expectation as they did in 2023.

Different from the trend of last year's downward trend, after the Hong Kong stock market correction to a certain extent this year, based on more proactive policy responses, external demand recovery, and the support of buybacks, there will be a true safety margin. Therefore, to seek true excess returns, it is still necessary to wait for the correction to a suitable level and then look for high-quality undervalued stocks in the high elasticity market of Hong Kong stocks.

III. Portfolio Rebalancing and Returns

During this period, Dolphin Jun will continue to concentrate on continuous rebalancing based on market and fundamental changes. Last week, the main adjustment was to exit Li Auto, mainly due to the observation of a downward trend in the business cycle. However, after the exit, the company has gradually entered Dolphin Jun's watchlist after a period of decline, and Dolphin Jun will pay attention to its potential reversal opportunities.

At the end of last week, the portfolio's return retreated by 3.7%, underperforming the relatively unchanged S&P 500 and the CSI 300 (-2.1%), but outperforming the Hang Seng Tech Index (-7.6%) and the MSCI China Index (-4.9%) Portfolio Performance Update

Since the start of testing until last weekend, the portfolio has achieved an absolute return of 36%, with an excess return of 52% compared to MSCI China. From a net asset value perspective, the initial virtual assets of Alpha Dolphin were $100 million, which has now risen to $137 million.

Individual Stock Contribution to Gains and Losses

Last week, the trigger for the decline in Hong Kong stocks was tension in the external environment. However, another major reason, in the view of Alpha Dolphin, is that the logic of financing repurchases of convertible bonds by Alibaba and JD.com has affected the logic of this rebound. Coupled with this recovery, the entire Hang Seng Index has risen by about 15% from the bottom, and the market has started to lock in profits.

During this decline, it is evident that high elasticity stocks with weak fundamentals and performance below expectations experienced significant declines. Whether it is quality companies like Li Auto, NetEase, Huazhu, or companies with consistently poor fundamentals like Bilibili and various offline catering and social service stocks.

On the other hand, companies with strong performance in the face of adversity have shown absolute strength in growth. Whether it is NVIDIA or Pinduoduo, their outstanding performance has allowed them to outperform the general market downturn caused by the rise in US bond yields.

Portfolio Asset Allocation

After Alpha Dolphin adjusted its virtual portfolio by removing Li Auto and Shell, it currently holds a total of 20 individual stocks and equity ETFs, with 5 core holdings and the rest as underweight equity assets, with the remaining in gold, US bonds, and US dollar cash. Currently, there is still a significant amount of cash and cash-like assets, and in the coming weeks, there will be further allocation to equity assets.

As of last weekend, the asset allocation and equity asset weights of Alpha Dolphin are as follows:

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Risk Disclosure and Disclaimer: Alpha Dolphin Research Disclaimer and General Disclosure Please refer to the recent Dolphin Research Portfolio Weekly Report articles:

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