Source: Kevin Strategy Research
Authors: Liu Gang, Wang Muyao, et al

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Against the backdrop of general weakness in peripheral markets, Hong Kong stocks unexpectedly experienced a strong rebound that had been lost for a long time last week, rising for five days. The Hang Seng Index closed up 8.8% to 17,651 points, the biggest weekly gain since October 2011, returning to November last year's level. Hang Seng Technology also surged 13.4%, the biggest weekly increase since November 2022.

At the sector level, real estate (15.7%), media and entertainment (Internet) at 13.5%, and optional consumption (e-commerce, automobiles, etc.) at 11.6% were the three sectors with the biggest increase, while the energy and raw materials sector declined slightly. However, the rotation between sectors was also very obvious last week. For example, the Internet led the way in the first half of the week, and then switched to real estate and non-banking on Friday.

Why did Hong Kong stocks suddenly soar, and what special factors are driving it? More importantly, how sustainable is it after the surge? In response to the general concerns of the market, our analysis is as follows.

Chart: Overseas Chinese stock markets have been rising for five consecutive days

Chart: Real estate and media and entertainment led the way, with energy and raw materials falling the highest

Chart: The sector rotates rapidly, with real estate and diversified finance sectors leading the way on Friday

What is driving the surge? The capital side is the main driving force behind the sharp rise. Fundamentals have not changed much, and policy expectations provide the catalyst

The capital side is the main driving force for Hong Kong stocks to surpass expectations. Trading in Hong Kong stocks has always been relatively light, so marginal changes in capital combined with short selling and compensation often lead to rapid and sharp increases. This is also a typical characteristic of Hong Kong stocks. After synthesizing various data and information, we found that active capital outflows from foreign capital continued (EPFR caliber), so we speculate that transactional and other types of capital may be the main ones. Southbound capital continues to flow in and marginal inflows into the new economy sector. Due to the large inflow of dividend assets previously, the allocation to the new Internet economy has fallen to a new low in 2019, and the rotation of capital is also in line with sector rotation.

The capital side is the main driving force for Hong Kong stocks to surpass expectations. Trading in Hong Kong stocks has always been relatively light, so marginal changes in capital combined with short selling and compensation often lead to rapid and sharp increases. This is also a typical characteristic of Hong Kong stocks. After synthesizing various data and information, we found that active capital outflows from foreign capital continued (EPFR caliber), so we speculate that transactional and other types of capital may be the main ones. Southbound capital continues to flow in and marginal inflows into the new economy sector. Due to the large inflow of dividend assets previously, the allocation to the new Internet economy has fallen to a new low in 2019, and the rotation of capital is also in line with sector rotation.

1) In terms of foreign investment, raising the ratings of the Chinese market and real estate sector by foreign banks may further boost investor sentiment, but the EPFR data we are tracking shows that active value capital has yet to form a clear return trend. As of last Wednesday, EPFR's overseas active capital outflows of US$310 million from the Hong Kong stock market, which is narrower than the previous week's outflow of US$420 million, but it has been outflows for the 43rd consecutive week. According to our breakdown in “How to Portray and Analyze Foreign Investment”, transactional capital accounts for 5%, sovereign and government-like background capital accounts for 10-20%, passive capital accounts for 20%, and active value capital accounts for 50%. Therefore, it is likely that transactional capital will be the main focus. Even if there is some return of allocated funds, it is probably more of a hedging switch to avoid the Bank of Japan's interest rate hike and fluctuations in US stocks. It has certain hedging and trading attributes, so it is still difficult to determine whether a continuous inflow can occur.

Chart: Overseas active capital flows out of the Hong Kong stock market for the 43rd week in a row

2) On the southbound side, capital inflows to the south accelerated markedly after the Spring Festival. Considering that the newly disclosed public fund holdings in the first quarter showed that public holdings and the share of southbound capital continued to decline, this portion of inflows is likely to be dominated by non-public funds. In terms of the sector, it mainly flowed into banking, energy, raw materials, telecommunications and other sectors after the Spring Festival. The share of holdings in new economic sectors such as the Internet fell to a new low since 2019, and the difference in allocation was quite obvious. There was a marginal inflow of capital into the new economy last week, so from the perspective of capital rotation, it also echoes the sharp rise in the Internet and other sectors last week (“Public 1Q24 Hong Kong Stock Investment: New Economy Positions Fell to a New Low Since 2019”).

Chart: Mainland public funds allocate 62.8% of Hong Kong stocks to the new economy

Chart: Southbound capital mainly flowed into banks, media, non-banks and other sectors last week

Macro fundamentals and corporate profits haven't changed much. Recent macro-high-frequency data are mixed, industrial production and real estate are still weak, and consumption has improved. 1) The production-side high-frequency index weakened 0.9% month-on-month and 1.5% year-on-year; 2) As of April 21, the consumer high-frequency index improved by an average of 1.6% month-on-month and fell 3.3% year-on-year. Among them, passenger car wholesale and retail sales increased by more than 20% month-on-month compared to the previous week, and the export container freight index rose 1% month-on-month. 3) In terms of real estate, the sales area of commercial housing increased by 3.1% month-on-month in the week of April 21, but there was a sharp year-on-year decline. The sales price index for second-hand housing was exchanged for volume, and the sales price index has continued to decline since March. 4) In terms of prices, pig prices and fresh fruit prices continued to weaken month-on-month, with an overall decline of 0.6%, while industrial product prices fell by nearly 1% month-on-month. 5) At the same time, fiscal spending and credit demand are also slowing. The year-on-year growth rate of general fiscal expenditure declined in the first quarter. In March, government fund spending fell 23.3% year on year, and the growth rate of general public budget expenditure turned negative. In terms of corporate profits, the 2024 profit forecast for the Hang Seng Index was slightly lowered by 0.1% last week. Among them, profits for raw materials and telecommunications services improved, and semiconductors and real estate declined the most. The sharp rise sector generally did not see a significant increase in profits. It can be seen from this that the sharp rise in the market was not driven by changes in fundamental factors.

Chart: Recent macro-high-frequency data are mixed. Industrial production and real estate are still weak, and consumption has improved

Chart: Profit improvements in raw materials and telecommunications services last week, with the most downgrades in semiconductors and real estate

Policy expectations and eventual factors provided some catalyst. On April 19, the Securities Regulatory Commission issued the “5 Capital Market-Hong Kong Cooperation Measures” (“Interpretation of the 5 Capital Market-Hong Kong Cooperation Measures”) and the Ministry of Finance's proposal to support the central bank to gradually increase liquidity in treasury bond trading, etc., all of which made investors have positive expectations for the advancement of other key measures in the future. In addition, optimization of aspects such as dividend tax on Hong Kong stocks and real estate policies in first-tier cities has also attracted much attention. Investors are advised to pay close attention to developments related to the Mid-Year Politburo meeting.

What are the prospects after the surge? Transactions are clearly overdrafted. Rotating capital is still cooperating with external pressure in the short term, and improving fundamentals still requires policy efforts

The rapid and unexpected surge in Hong Kong stocks has surpassed the expectations of many investors, so the question that people are most concerned about right now is how sustainable will it be after the surge? After all, the drama, which surged and then went back down again and again, has been played over and over again over the past year. We think it can be considered from the following dimensions:

1) At the transaction level, capital-driven rapid increases are often fast, but overdrafts are also fast, and need to be supported by continuous long-term capital inflows. The rapid rotation between sectors last week also illustrates this. Judging from technical and sentiment indicators such as the degree of overbought and the share of short sales, the Hong Kong stock market continued to rise for five days last week. Currently, the overbought level has reached a new high since January 2023, and the share of short sales transactions has quickly fallen back to a recent low of 16%. The Hang Seng Index around 18,000 is also a key resistance level on the daily, weekly and monthly lines, so it is clearly emotionally overdrawn.

Chart: The current level of overbought market has reached a new high since January 2023

Chart: The share of short sales transactions quickly fell back to a recent low of 16%

2) In terms of capital rotation, if capital is mainly transactional capital and rotates to the Hong Kong stock market to temporarily avoid overseas risks, momentum will also decline after external pressure is released, so we need to pay attention to subsequent changes in long-term and allocated capital. In the short term, the pressure on the external environment may take some time to ease. The pressure on the Federal Reserve is expected to ease until the end of the second quarter, and the first quarter performance period for US stocks also basically corresponds to mid-May (“The threshold for the Fed to cut interest rates” and “US stock pullback helps restart interest rate cut transactions”).

3) Fundamentally, the reallocation of long-term capital requires fundamental improvements and coordination. In particular, fiscal policies are strengthened to deal with the current problems of declining inflation and credit contraction. External demand, driven by US demand, is likely to weaken month-on-month in the second quarter. Further tightening of financial conditions led to a decline in US real estate in March. We believe that more fiscal stimulus that directly reaches the demand side is the key. It is recommended to pay more attention to the degree of improvement in monthly fiscal balance and social finance data, as well as positive developments such as central bank debt purchases and important meeting policies.

Editor/jayden