Source: Zhongjin Dim Sum
summary
Macroeconomic environment: The core of breaking the game is growth, the key to growth is credit, and the credit gripper is finance
Compared to the external environment, growth is the key to reversing the current negative spiral of pessimistic expectations and financial sentiment. The key to steady growth is also stable credit. However, since various departments generally lack the will or ability to increase leverage, the central government has become the main reliant on leveraging. In addition, first-tier real estate also plays an important role in preventing continued contraction of leverage and stabilizing expectations.
However, for most of this year, “tight finances” and “weak” real estate have inhibited the start of the credit cycle. Even if financing costs continued to decline, many policies after July did not fully resolve these credit leniency issues, explaining the market's lackluster reaction. However, from another perspective, it also fully illustrates the importance of issuing additional treasury bonds recently, even greater than the various other policies introduced since July. In other words, leveraging by the central government is in the direction of “symptomatic treatment,” but in the future, if the scale is larger and the pace is faster, it may have a better positive feedback effect. After all, the policy also has a “preservation period” where it has a certain effect.
Market trend: Hong Kong stocks are in the process of gradually bottoming out, and the benchmark situation has room to rise 15%
Based on the basic assumption that the policy is progressing gradually and interest rates on US bonds are slowly falling, we judge that Hong Kong stocks are in the process of gradually bottoming out, and there is 15% room for improvement in the benchmark situation. The policy is currently at the bottom of the policy, but as it has been repeated many times this year, it will still take time to transition to the bottom of sentiment and market. Larger and sustainable space still requires more “symptomatic” policy coordination to gradually usher in the bottom of capital flows and profit bottoms. The downside risk is that the introduction of “symptomatic” policies is weaker than expected. Under the benchmark scenario, we expect Hong Kong stock earnings to increase by 4.5% (non-financial 4.7%, corresponding real estate 7%), valuation expansion by 10% (implied US debt of 4%, risk premium falling from 8.2% to 7.8%), and an upward margin of 15% for the index. The optimistic scenario index has an upward margin of 25-30% (profit growth of 10%, valuation expansion of 15%); pessimism assumes a 0% increase in profit and a 5% expansion in valuation.
Configuration suggestions: “pick up cheap”, “heavy structure”; dumbbell structure, with three main lines
We expect that intensive policy expectations from the end of the year to the first quarter of next year, a slowdown in US bond interest rates, and an easing of the geological situation may contribute to a wave of restorative rebound. At this time, Hong Kong stocks are more flexible, and highly elastic and interest-sensitive industries may benefit more, such as biotechnology, technology hardware, the Internet, and new energy. However, after the restoration is completed, and before the policy becomes stronger, we suggest taking the “pick up the cheap” approach and following the “dumbbell type” structure that combines offense and defense. High-end technology, the logic of going out to sea, and long-term dividend ability are the three main lines of logic.
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Macro environment: The core of breaking the game is credit, and the credit gripper also lies in finance
Growth and policy: the current direction is “symptomatic”, but scale and timeliness are just as important
The weak performance of Hong Kong stocks in 2023 since mid-2021 continues. The three-year decline fully demonstrates that only undervaluations and high risk premiums are not reasons for the continuation of the reversal, yet external disturbances such as interest rates on US bonds and foreign capital flows are also not decisive factors in market trends. The core of the performance of the Hong Kong stock market is still internal growth. Since the beginning of the year, when fundamentals have been repaired less than expected, the market has rebounded several times even when pressure from the external environment eases or policy stimulus is often short-lived. Therefore, the key to boosting market performance and achieving a breakthrough in the situation is growth. So how do you achieve growth? We think it depends on the commencement of credit expansion.
The current “challenge” is that demand for new credit is weak, limiting the commencement of credit expansion. The reason for this round of recovery is slow. The reason is that the return on investment is declining faster than financing costs, and the transmission of broad currency to credit is poor. Looking by sector: 1) Residential sector: The decline in real estate returns is dominated by pressure on housing prices, and the growth rate of commercial housing sales and mortgages is sluggish. 2) Enterprise sector: The downturn in the profit cycle limits the start of the production cycle. Large enterprises still face the dilemma of return on investment falling short of financing costs, and financing costs for small enterprises may be higher. 3) Government departments: The overall credit of government departments has not expanded significantly. We estimate that the fiscal impulses measured by different calibers since this year have all fallen into the negative range. The continued contraction of the broad fiscal deficit compared to last year has caused the fiscal pulse to hit a new low since 2021.
Therefore, in a situation where various departments generally lack the will or ability to increase leverage, the central government's leverage has become the main reliance. Furthermore, real estate in first-tier cities is essential to avoid further leverage contraction and stabilize expectations.
Looking ahead, if there are further changes in fiscal and real estate policies, which are the main drivers, it is expected that the current pattern of weak internal growth dynamics and weak economic fundamentals and recovery will be effectively improved.
Finance: The fiscal pulse has been corrected or corresponding to the central government's increased leverage of 3-5 trillion yuan. The current direction of issuing 1 trillion yuan treasury bonds is “symptomatic,” but it is still necessary to observe follow-up efforts to support the recovery of the fiscal pulse. In a situation where residents and the business sector are not willing to increase leverage, we believe that increased leverage by government departments will also help extend government credit to the private sector and promote the beginning and upward of the subsequent private sector credit expansion cycle (Chart 6).
Real estate: Focus on policy optimization in frontline and some high-energy cities where there is still room for fundamentals. The relaxation of the simple loan restriction policy is limited due to the low share of improvement demand (about 18% in 2022), and the relaxation of the purchase restriction policy supports real estate sales depending on the fundamentals of the city. Considering factors such as the new resident population, registered population, and birth population, there are still 9 cities where there is room for policy and fundamentals, accounting for 20% of real estate sales. We estimate that the release of purchase restrictions or driving the sales area has improved year-on-year. The year-on-year decline in real estate development investment has narrowed by 1ppt.
It should be pointed out that the policy also has a “preservation period” to have a certain effect, so if the pace is faster, it may have a better positive feedback effect.
In addition to this, 1) Exports: Or a year-over-year recovery, but overall US demand falls or limits room for significant improvement. 2) Investment and inventory: An increase in return on investment is still a prerequisite. Infrastructure investment depends on financial support, and the issuance of relevant treasury bonds is expected to fill the support of capital within the budget for infrastructure investment. While real estate in first-tier cities is still restricted, real estate sales may still be weak, making it difficult to support a recovery in real estate investment. 3) Service consumption is resilient, but its contribution is limited. Currently, service consumption by Chinese residents accounts for 18% of GDP (vs. 40% of the US), and prospects for subsequent restoration depend on growth and income expectations; consumption of durable goods (automobiles, household appliances, etc.) is more related to the real estate cycle, so the overall recovery is expected to be moderate.
Chart 1: The decline in the return on real estate investment in the residential sector was faster than the lower interest rate for the first and second home loans fell faster
Chart 2: Affected by the decline in housing investment income, real interest rates on housing loans in the residential sector have now risen to historic highs
Chart 3: The current equity financing cost for all A non-financial petrochemical companies is 8.9%, which is higher than its ROE level of 7.5%
Chart 4: Loan-weighted average interest rates (3.9%) and bond financing costs (3.8%) are also close to corporate ROA levels
Chart 5: Fiscal impulses measured by different calibers have all fallen into a negative range since this year, and fiscal stimulus has weakened compared to last year
Chart 6: Increased leverage by government departments will help extend government credit to the private sector
Market trend: In the process of gradual bottoming out, the benchmark situation has an upward margin of 15%
Corporate profit: The benchmark situation increased by 4.5%, a moderate recovery from 2023
Based on the above analysis of growth and policy, we have a preliminary forecast that under the benchmark scenario, the profit growth of overseas Chinese stocks in 2024 will be 4.5% (vs. 2% in 2023), with non-financial growth of 4.7% year on year and finance growth of 4.3% year on year. Let's look at it specifically:
Revenue growth: From the top down, we expect non-financial sector revenue to grow by 3.7% in 2024 (vs. a 1.7% year-on-year increase in non-financial revenue in 2023). The “symptomatic treatment” policy continues to be strengthened, which is expected to boost residents' confidence, but the current policy mainly focuses on real estate, debt packages, urban village renovation, and other fields that do not have rapid results in the short term, so we expect that the recovery in income growth in 2024 may be relatively moderate.
Profit margin: Based on cost and demand assumptions, we expect profit margins to rise slightly to around 5.0% in 2024 (vs. 4.9% in 2023). Currently, PPI and CPI are in a low year-on-year range, but since August, they have continued to bottomed out and rebounded. It is expected that 2024 PPI will change from negative to positive, and CPI may rise further year over year, but the slope may be relatively limited (Chart 10). Furthermore, the improvement of operations and industry integration of middle and downstream enterprises is expected to see further results in 2024, which will boost profit margins to a certain extent. Among specific industries, sectors such as upstream industries and raw materials, etc., which are clearly under pressure in 2023, as well as areas related to the real estate industry chain that benefited from a low base and policy optimization, deserve attention. The downstream consumer sector is expected to continue to improve under the boost of residents' confidence, but the slope depends on steady growth progress and the recovery of income expectations.
Looking ahead, the point and extent of profit recovery largely depends on the pace of macroeconomic and policy improvements: 1) The benchmark situation is likely to be a path of support rather than promotion. We expect the profit growth rate in 2024 to be about 4.5%, the current market consensus forecast is about 10%, and the MSCI China Index EPS is expected to increase 15% year over year; 2) The optimistic situation corresponds to real estate and financial strength exceeding expectations. As described above, first-tier cities have completely liberalized purchase restrictions and central debt issuance reached the level of 5 trillion yuan, and profits can achieve a 10% corresponding growth forecast; 3) pessimistic Under the circumstances, “symptomatic” policies are no longer being introduced, and profits are likely to be the same as in 2023.
Chart 7: Under the benchmark scenario, profit is expected to increase 4.5% year over year, and non-financial growth is expected to increase 4.7% year over year
Chart 8: Under the benchmark scenario, the profit margin is expected to rise slightly to 5.0%, corresponding to a 4.5% year-on-year increase in profit
Chart 9: The inventory of finished products produced by Chinese industrial enterprises rose year on year in September, and the month's revenue and PPI still declined year on year
Chart 10: Market expectations that PPI and CPI have bottomed out and rebounded year over year
Valuation level: Risk-free interest rates decline or drive 10% expansion
The dynamic price-earnings ratio of the MSCI China Excluding A Shares Index has now declined to 9.0x, which is in the historical quartile of 5% since 2015, mainly dragged down by rising risk premiums (Chart 12). We expect the 2024 valuation to rise slightly. If fundamentals improve markedly, the room for rebound may expand further.
Based on our matching estimates of economic growth represented by indicators such as PMI and liquidity represented by risk-free interest rates, the current reasonable valuation of the Hong Kong stock market is only slightly higher than the actual valuation by about 0.5x (Chart 14), so the momentum for subsequent valuation repairs is largely affected by the extent to which risk-free interest rates and risk premiums have declined. Looking at it concretely,
► Risk-free interest rates are expected to decline to 3.6% in the second half of 2024, and are expected to decline to 3.6%. Looking ahead, risk-free interest rates in the Hong Kong stock market are still expected to decline, providing support for valuations. However, the decline in US bond interest rates may be driven by risk exposure in the real sector or financial markets, or suppress global market sentiment, which in turn will drag down valuations. We expect that under the benchmark situation, interest rates on 10-year bonds in 2024 may remain around 2.7%, interest rates on 10-year US bonds are expected to fall to around 4%, and the risk-free interest rate corresponding to the Hong Kong stock market will fall back to about 3.6%.
► The risk premium has moved upward from the center and the decline in expectations of a moderate recovery in 2024 or is relatively limited. The benchmark situation has declined slightly by 0.5ppt from the current level. Looking ahead to 2024, with the gradual implementation of policy expectations, fundamentals are expected to continue to be repaired and residents' confidence reshaped, leading to a decline in risk premiums. However, uncertain factors such as falling external US demand in the second half of the year may still interfere. The implementation time and implementation effects of “symptomatic” policies such as internal real estate and central government leverage remain to be seen. Overall, under the long-term trend of a moderate recovery in 2024 combined with an upward shift in the center, the extent of risk premium decline may be relatively limited.
Based on the above analysis, we estimate that the valuation under the 2024 benchmark scenario is expected to expand 10% compared to the current one. Among them, the decline in risk-free interest rates will contribute 60%, and the lower risk premium will contribute 40%. The optimistic scenario is expected to expand 15-20%, while the pessimistic scenario is 5%.
Chart 11: MSCI China (excluding A shares) dynamic P/E recently contracted to about 9.0 times, below 0.7 times the long-term average
Chart 12: At the valuation level, risk premiums are the main drag, and the recent rise in risk-free interest rates has brought restraint
Chart 13: The rise in risk-free interest rates since March has dragged down overall performance and expanded
Chart 14: The degree of deviation between reasonable valuations and actual valuations in the Hong Kong stock market is limited
Chart 15: Hong Kong stock valuation operations are less cyclical, and the downward trend is obvious
Chart 16: Risk premiums are negatively correlated with active foreign capital flows, and foreign capital outflows increase risk premiums to a certain extent
Liquidity: The return of overseas capital still needs to improve fundamentals, and southward inflows are expected to continue
Southbound capital: Factors such as domestic easing, lower valuations, and high dividends to hedge exchange rates continue to provide appeal to southbound capital. The overall trend of southbound capital inflows continued this year (Chart 18). We believe that the continued easing of domestic monetary policy in recent years has created preconditions for its continued inflows. In addition, since this year: 1) the performance of Hong Kong stocks has been more sluggish compared to A-shares, and the AH discount premium has risen, making valuations attractive; 2) in the context of the overall decline in the RMB exchange rate, some Hong Kong stocks can have a hedging effect; and 3) the high dividends of some Hong Kong stocks and the stable cash flow returns provided by defensive models are all expected to be attractive to southbound capital. If subsequent policies are further strengthened, the high-quality growth targets unique to Hong Kong stocks are likely to receive more attention and favor from southbound investors.
Overseas capital: The static view is that the allocation is already low, but the return flow still depends on improving fundamentals. The flow of foreign capital is a lagging indicator. It is a comprehensive result of overseas liquidity, domestic fundamentals, and risk events. China's domestic fundamentals are even more critical. Based on three types of portrayal of foreign investment, we believe that the trend of value capital is more noteworthy than transactional and sovereign (Chart 19). 1) Transactional (hedge funds and individuals, etc., accounting for 5% or more): This type of capital is not completely influenced by fundamentals, and it is difficult to treat them as “ballast stones” that “buy and hold” to stay in the market for a long time; 2) Sovereign type (sovereignty, pension, or donations, etc., accounting for 10%-20%): Since this type of capital is heavily influenced by non-fundamental factors, it can be solved in the short term, and is less likely to flow back in the short term. 3) Value-type (mainly mutual funds, accounting for 70-80%): Currently, allocations are already low, and domestic economic expectations and fundamentals have stabilized and improved thereafter. Combined with the current overall low allocation, we believe that a return of value capital can still be expected (Chart 20).
Chart 17: Continued outflow of overseas active capital after mid-March
Chart 18: Continued inflows of capital to the south
Chart 19: In the foreign investment portrait, value capital dominates (70~ 80%), while sovereignty and transactional capital account for about 10-20% and 5% respectively
Chart 20: Under pessimistic and extreme hypotheses, it is assumed that the underallocation ratio of each type of fund will drop by one times or be halved from the benchmark ratio
Configuration suggestions: “pick up cheap” and “restructure”, configure three main lines
We expect that intensive policy expectations from the end of the year to the first quarter of next year, a slowdown in US bond interest rates, and an easing of the geological situation may contribute to a wave of restorative rebound. At this time, the elasticity of Hong Kong stocks is greater than that of A-shares, and industries that are highly elastic and interest-sensitive may benefit even more, such as biotechnology, technology hardware, the Internet, and new energy. At the same time, the fall in interest rates on US bonds is also worth paying attention to, boosting sectors that are sensitive to related interest rates.
However, until more vigorous policies are implemented, we remain conservative in our view of the upside. Therefore, the overall strategy of “picking up the cheap” can be adopted, and focusing on structure is still a basic idea. It still uses a “dumbbell” structure that combines offense and defense (Chart 21). One end is high dividends that pursue stable returns (such as telecommunications, utilities, and energy); the other end is high-quality growth that is expected to enjoy more growth momentum, including high-end technology (such as the semiconductor industry chain, software and services, consumer electronics and innovative drug-related sectors) and offshore logic (such as general equipment manufacturing, transportation, electrical machinery and equipment manufacturing).
At the same time, we remind investors to pay attention to thematic sector opportunities that can benefit first when signals of a phased rebound arrive: such as 1) interest-sensitive industry opportunities in a declining interest rate environment, focusing on semiconductors, automobiles, media and entertainment, software and biotechnology (chart 23, chart 24); 2) industrial opportunities benefiting from rising demand after the inventory cycle bottoms out, focusing on chemical fiber manufacturing, general equipment, electronic communications, textile manufacturing, leather footwear, furniture manufacturing; upstream raw materials and construction machinery exports, etc.; 3) the high beta sector that has previously exceeded the decline and is more sensitive to the rebound, and focus on the high-beta sector, which is more sensitive to the rebound Creatures Sectors such as technology, the Internet, and new energy.
Chart 21: The “dumbbell” configuration structure of Hong Kong stocks
Chart 22: High-end upgrade vs. mid-tier overseas
Chart 23: Hong Kong stocks ushered in phased opportunities during a period of declining interest rates
Chart 24: Sectors sensitive to falling interest rates: semiconductors, new energy, media and entertainment, software and biotechnology, etc.
Edit/Jeffrey