Source: CICC Strategy
Authors: Liu Gang, Zhang Weihan, et al
summary
The central bank's unexpected downgrade last week drove a sharp rebound in the market. In fact, last week we showed investors that some technical indicators, such as valuation, risk premiums, and investor sentiment, were close to or even surpassing the extreme levels of the bottom of the previous few rounds of the market. Therefore, the market received some support at this level, and it is not surprising that it even rebounded under a positive catalyst.
However, this rebound has also sparked quite a bit of discussion about what is currently an inflection point in the market. We tend to think that currently the market is still in the rebound phase brought about by emotional healing. The relatively relaxed environment overseas, low valuations, and domestic policy support all made it not difficult for the market to rebound similar to the beginning of 2019 or the end of 2022. But a real reversal of the trend will require more “symptomatic” policies (particularly large-scale financial support) to address the private sector's credit crunch. And no matter what form the policy takes, it needs to be strong enough to be expected to achieve its goals.
At the allocation level, domestic downgrades and subsequent further interest rate cuts are expected to drive rebound recovery driven by liquidity. Technology and small-cap growth stocks will benefit even more at this time. If more fiscal stimulus policies are implemented, there may be more room for growth in cycles and core assets. However, if both of these aspects are not realized, the strategy of focusing on high dividends and “dumbbell” allocations that we have been recommending since last year is still expected to continue to outperform.
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Has the market reached an inflection point?
Market trend review
After many recent rounds of panic sell-offs brought the Hong Kong stock market to its lowest point since October 2022, driven by active policies such as domestic downgrades, the week finally ushered in the first weekly rise since this year. Overall, the major indices all showed significant gains. The Hang Seng Index, Hang Seng State-owned Enterprises, and MSCI China Index rose 4.2%, 4.5%, and 3.4% respectively last week. The Hang Seng Technology Index, which is dominated by the growth sector, lost, with an increase of only 1.8%. In terms of sectors, the energy and telecommunications sectors led the way, reaching 10.5% and 8.8% respectively last week, while the healthcare and information technology sectors lagged behind, falling 3.8% and 2.1%, respectively.
Chart: The MSCI China Index rose 3.3% last week, with energy and telecommunications sectors leading the way
Market outlook
The overseas Chinese stock market showed a “roller coaster” trend last week. The market remained weak at the beginning of the week and continued to recover. This has something to do with the January LPR “stand still” announced at the beginning of the week. Although the MLF interest rate remained unchanged the previous week, the market already anticipated that the LPR should also not change, but it still had an impact after the actual announcement. At the same time, recent developments in liquidity and derivatives may also amplify market fluctuation pressure. The Hang Seng Index fell below the 15,000 intraday mark, just one step away from the market low in October 2022.
However, as we published last week's “”Where did the market fall?》The report suggests that market technical indicators, such as valuation, risk premiums, and investor sentiment, have all approached or surpassed extreme levels at the bottom of previous rounds of the market, and the monthly support level of the Hang Seng Index is also around 14,600. Therefore, in this context, the market received some support at this level, and it is not surprising that there was even a certain rebound under a positive catalyst. In this sense, the apparent rebound in the market last Wednesday was not completely unexpected; it is basically consistent with our judgment.
The central bank's unexpected reduction of 50 bp drove the market to a sharp rebound, triggering many discussions about what is currently an inflection point in the market, even though 2023 has experienced many rounds of “rushing up and falling”. The question is, are current catalysts sufficient? If not enough, what can actually cause a trend reversal rather than just a fleeting rebound?
In fact, it is not difficult for the short-term market to rebound by a certain margin. The relatively relaxed environment overseas, low valuations, and domestic policy support can be achieved. Whether it was the rebound in early 2019 (the Federal Reserve hinted at the end of interest rate hikes, the Central Bank of China downgraded) or the rebound at the end of 2022 (the US core CPI reached an inflection point, China optimized its epidemic prevention and control policy), and there is no essential difference. But the threshold and requirements for a complete reversal of the real trend are greater.
Chart: We don't think it's difficult for the market to rebound in the short term under the current situation (such as the beginning of 2019 or the end of 2023)
We tend to think that the current market is still in the rebound phase brought about by emotional recovery, and that a real trend reversal requires more “symptomatic” policies (large-scale financial support) to resolve private sector credit contraction problems (”Hong Kong Stock Market Outlook 2024: Fast and Fast”). We have pointed out many times in 2023 that credit expansion was delayed or even blocked for a while due to two factors: still high financing costs for enterprises and residents and low investment return expectations. In the current macroeconomic environment, timely and “symptomatic” policies, particularly significant fiscal stimulus, are still essential to reverse the credit cycle. In our view, various fiscal policy options, including issuing special treasury bonds, the central bank restarting PSL, and increasing the deficit rate, are all moving in the right direction. However, whatever form they take, policies need to be strong enough to achieve the goals. Our estimates show that if the broad fiscal deficit pulse in 2024 remains flat and positive compared to 2023, it would correspond to a net increase in fiscal deficit of about 3 trillion yuan (”Why did Hong Kong stocks lose again in 2023?”). Of course, a 50 basis point reduction and possible further interest rate cuts in the future will help ease liquidity pressure and reduce financing costs, but fiscal expansion is still critical to reversing the current situation.
Externally, the US economy is still showing resilience, bringing uncertainty to the Federal Reserve's interest rate cut path, which may become a potential source of market volatility. The annualized growth rate of US GDP in the fourth quarter of 2023 was 3.3%. Although it was lower than 4.9% in the 3rd quarter, it was still significantly higher than the market's consensus forecast of 2.0% and the Atlanta Federal Reserve's GDPNow model's 2.4% forecast, indicating that the US economy remains resilient. The current CME Federal Reserve policy observation tool shows that the futures market has corrected previous expectations that were too optimistic about cutting interest rates early, and it is expected that there is a probability of more than 50% that the Fed will not start cutting interest rates before May. Therefore, the upcoming FOMC meeting and potential statements surrounding this year's interest rate cut path are the core of attention to next week. Furthermore, changes in Sino-US relations and US regulatory measures on some industries also deserve special attention.
Chart: There is still uncertainty about the path of interest rate cuts, and interest rates on 10-year US bonds are still hovering above 4%
Looking ahead, we reaffirm our previous view that further policy support, particularly fiscal policy support, is still essential for the Hong Kong stock market to reverse the current situation. The recent unexpected downgrade by the Central Bank of China and subsequent further interest rate cuts can drive a rebound and recovery driven by liquidity. Technology and small-cap growth stocks are even more beneficial at this time. If more fiscal stimulus policies are implemented, there may be more room for growth in cycles and core assets. However, if both of these aspects are not realized, the focus on high dividends and the “dumbbell” allocation strategy that we have been recommending since last year is still a good investment strategy, and it is expected that it will continue to outperform. Furthermore, it should be pointed out that the State Assets Administration Commission said last week that it will further study incorporating market value management into the performance assessment system for central enterprise heads. We recommend that investors continue to pay attention to the standards of central state-owned enterprises with high dividend capacity and potential (”The value of high-dividend investment under the new macro situation”).
Chart: Judging from historical experience, the growth sector usually outperforms after the Central Bank of China indicates a downgrade
Specifically, the main logic underpinning our views above and the changes we need to pay attention to last week mainly include:
1) The central bank of China's downgrade supports economic growth. At a press conference held last Wednesday, Central Bank Governor Pan Gongsheng unexpectedly announced that the deposit reserve ratio of financial institutions will be lowered by 0.5 percentage points starting February 5 this year. The central bank expects that this move may inject 1 trillion yuan (equivalent to 140 billion US dollars) of working capital into the market. This is the first time since this year that the central bank lowered the reserve ratio after two downgrades last year. Governor Pan said at the press conference that the central bank will make efforts to promote a moderate recovery in prices so that the scale of social financing and money supply match the expected goals of economic growth and price levels. Furthermore, he pointed out that the market generally anticipates a shift in the Federal Reserve's monetary policy, which is objectively beneficial for China to expand the operating space for monetary policy. Furthermore, the Central Bank of China also announced that starting January 25 this year, it will cut interest rates for agricultural support reloans, small reloans, and rediscount interest rates by 0.25 percentage points respectively.
2) The State Assets Administration Commission stated that it will further study the integration of market value management into the performance assessment system for heads of central enterprises. Last week, Xie Xiaobing, head of the Property Administration Bureau of the State Assets Administration Commission, said at a press conference that further research will be carried out to include market value management in the performance assessment of central enterprise heads, guide central enterprise leaders to pay more attention to the market performance of listed companies they control, promptly convey confidence and stabilize expectations through the application of market-based methods such as stock growth and repurchases, increase cash dividends, and better return returns to investors.
3) The US economy remained resilient beyond expectations in the fourth quarter of 2023. As inflationary pressure eased, the growth rate of the US economy clearly exceeded market expectations in the fourth quarter of last year. Specifically, the US GDP annualized growth rate reached 3.3% in the fourth quarter of 2023, which is significantly higher than the 2.0% expected by the market and the 2.4% forecast of the Atlanta Federal Reserve's GDPNow model. Strong consumer spending, exports, and state and local government spending combined to drive GDP growth in the fourth quarter. The real GDP of the US grew by 2.5% throughout 2023, better than market expectations (2.4% increase) and 2022 growth rate (1.9%).
4) Liquidity: Southbound capital inflows have maintained momentum, while overseas capital has continued to flow out over the past 30 weeks. Specifically, data from the EPFR shows that overseas active funds left the overseas Chinese stock market last week, with a total outflow of 650 million US dollars (the total outflow volume of 520 million US dollars in the previous week), which was 30 consecutive weeks of outflow from the overseas Chinese stock market. Corresponding to this, southbound capital continued to flow in last week, and mainland Chinese investors bought more than HK$4.5 billion in Hong Kong stocks through the Hong Kong Stock Connect.
Chart: Overseas active funds have continuously flowed out of overseas Chinese stock markets for the past 30 weeks
Configuration recommendations
Until more favorable policies are implemented, we believe that the overall dumbbell configuration strategy is still effective in the current environment. The stable cash flow sector (high dividend ratio, such as telecommunications, utilities, and energy), the high-end technology upgrade sector (technology hardware, semiconductors), and the offshore sector of mid-tier dominant industries (construction machinery, automobiles and components, new energy and photovoltaics, consumption of some products and brands, etc.) will be the three main lines of core focus.
Editor/jayden