Source: CICC Strategy

Market trend review

The Hong Kong stock market continued its weekly decline. In addition to the return of profits that began the week before, factors such as weak recovery in domestic growth, some potential policy uncertainties, and outflows of foreign capital also collectively dampened investor sentiment last week. Among the major indices, the Hang Seng State-owned Enterprises Index saw the biggest decline, falling 3.2% last week. The Hang Seng Technology Index, MSCI China Index and Hang Seng Index fell 3.1%, 3.0% and 2.8% respectively. On the sector side, the energy sector was the only sector that achieved positive returns last week, rising 1.9%, while the real estate, banking and insurance sectors lagged behind, falling 5.0%, 4.5%, and 4.5%, respectively.

Market outlook

After the strong and rapid rise of Hong Kong stocks since the end of April has outperformed almost all global markets, the current round of rebound, mainly driven by capital and risk appetite, seems to have lacked momentum. The past two weeks have shown clear signs of profit recovery. Compared with the high in mid-late May, the Hang Seng Tech Index, which is dominated by the growth sector, has accumulated a cumulative decline of more than 10% over the past two weeks, and the Hang Seng Index has once again fallen to around the 18,000 mark. Over the past few weeks, we have continued to remind investors that after the market showed clear signs of being overbought in the short term, and the risk premium quickly fell back to the level close to the market high in early 2023, it was not surprising that the market was divided and that some investors wanted to make a profit settlement. However, when the market actually showed such a rapid and sharp correction, it still caught most investors off guard, and raised market concerns about whether the current round of upward trend was over.

Looking back at this round of rebound, we believe that capital aspects (short-term transactional funds and some regionally allocated funds that have returned due to rebalancing demand) and corresponding risk appetite restoration (reflected in falling equity risk premiums driving up valuation) are the main drivers of this round of growth. However, against the backdrop of no significant change in fundamental profits, the nature of this capital and the rebound driving characteristics behind it can also explain why the market often faces a certain profit return pressure after short-term overpurchases (the RSI overbought level once climbed to the highest level since the beginning of 2021, and the share of short sales transactions fell to a recent bottom of 12.9%). Since the beginning of May, we have continued to suggest that the market is close to our target point in the first phase, that is, around 19,000-20,000 points. The above points also correspond to the level of the Hang Seng Index equity risk premium falling back to the level before the Politburo meeting in July 2023 and when the market was high in early 2023, respectively.

In addition to short-term indicators such as investor sentiment, which were once at extreme levels, causing profit recovery pressure, a series of short-term uncertainties also dampened market risk appetite last week. First, the domestic manufacturing PMI for May, which was announced last Friday, unexpectedly fell into a contraction range. Among them, the new orders and export order segments fell 1.5 and 2.3 percentage points respectively in May and both fell into the contraction range. The phenomenon of weak domestic and foreign demand was further highlighted. At the same time, there has been a marked increase in raw material prices over the past two months. High-frequency data also showed that the prices of raw materials such as rebar, aluminum, and cement rose 1.2%, 5.3%, and 5.3%, respectively, at the end of May. Although the rise in raw material prices is expected to boost the level of inflation to a certain extent and benefit the profits of upstream companies, this may also be at the cost of squeezing the profit margins of middle and downstream enterprises. Especially in the current context where domestic and foreign demand continues to be sluggish, this impact may be more serious. Furthermore, China's central bank media “Financial Times” last week's statement that treasury bonds may be sold if necessary also raised concerns in the market about future domestic liquidity prospects. In our opinion, the central bank's move is probably not intended to actually tighten overall liquidity, but more to prevent the recurrence of events such as market fluctuations caused by large-scale bank wealth management redemptions at the end of 2022. After all, the market's demand for medium- to long-term treasury bonds has been strong recently. However, this may still cause the market to be confused by concerns about tightening liquidity, or even the impact of a decrease in the supply of safe assets. This factor, combined with the Federal Reserve's recent “hawkish” stance, may cause liquidity to be tight in the near future. In this environment, EPFR's overseas capital and northbound capital flowed out at the same time last Monday, which also amplified market fluctuations to a certain extent.

Looking back, the ups and downs of the past month were all due to the excessive pessimistic and optimistic expectations taken into account by the market. In the future, the market is expected to gradually return to reality and fundamentals, or fluctuate and consolidate at the current level (corresponding to around 18,000 points of the Hang Seng Index), waiting for more new catalysts. After experiencing a sharp correction over the past two weeks, many of the technical indicators we mentioned in the previous article have basically returned to normal levels. Among them, the equity risk premium rebounded from 6.7% to 7.6%, basically returning to near the level of October last year, and is already higher than the long-term historical average; the RSI even fell into the oversold range on the 6th, falling sharply to 24. Looking ahead, we believe that as risk appetite has been fixed, the market may require more catalysts to rise further in the future, but it will not completely recoup all of the gains. Unless extreme circumstances occur, after all, marginal changes in policy attitudes, the return of overseas capital, and valuation repairs are all real changes.

Looking ahead, the future upside of the market may depend on changes in the following factors:

1) Risk-free interest rate: If 10-year US bonds fall from the current 4.5% to around 4%, it is expected to push the market to around 20,500-21,000 points. However, it is still too early to make this judgment, because further easing of financial conditions will support US demand and prices, and will instead curb the room for the Fed to cut interest rates in the short term and further decline in US bond interest rates. Furthermore, recently, several Federal Reserve officials have once again shown a “hawkish” attitude.

2) Profit growth: If earnings increase by 10% in 2024, the Hang Seng Index is expected to rise to 22,000 points or more. However, at present, we judge that the profit growth of overseas Chinese stocks in 2024 is 5%, which is still lower than the 10% market's consensus expectation. To achieve 10% profit growth, the overall scale and speed of fiscal stimulus is critical, especially the issuance of special treasury bonds and ultra-long bonds, and the implementation of the recent “combo punch” of real estate policies. In other words, effective policies need to be fast, strong, and “symptomatic” before they can be expected to reverse the decline. At the same time, we recommend that investors pay close attention to the upcoming Third Plenary Session of the 20th Central Committee to be held in July, especially the statements on medium- to long-term development goals and directions.

In an environment of market consolidation, it is recommended to pay more attention to structural opportunities. On the one hand, high-dividend sectors may reap the benefits of short-term market shocks, expectations of potential tax policy adjustments, and market concerns about growth and external disturbances. In addition to traditional high-dividend sectors such as telecommunications, energy, and utilities, some categories such as the Internet, durable consumer goods, and consumer goods have stable cash flow and high shareholder returns, so we think it is also expected to become an alternative sector to the “high dividend concept.” On the other hand, we believe that technology hardware and consumer electronics (such as AI PCs), leading companies benefiting overseas, and consumer service sectors related to travel, travel, and leisure and entertainment products are expected to become the main choices for investment structure opportunities.

Specifically, the main logic underpinning our views above and the changes we need to pay attention to last week mainly include:

1) Macro: China's PMI unexpectedly fell into a contraction range in May, indicating that economic recovery still requires policy support. According to data released by the National Bureau of Statistics on Friday, China's official manufacturing PMI fell into a contraction range in May, falling from 50.4 in April to 49.5, which is significantly lower than the agreed market forecast of 50.5. Specifically, most sub-indices declined month-on-month. In particular, the new export orders sub-index fell into a contraction range for the first time in three months, indicating that external demand and export growth are under pressure. Meanwhile, the non-manufacturing PMI also fell slightly to 51.1 in May from 51.2 in April.

2) More first-tier cities in China relax their real estate purchase restrictions. A number of first-tier cities, including Shanghai, Shenzhen, and Guangzhou, announced new housing purchase incentives last week. For example, Shanghai cut the minimum down payment ratio for the first home and the second home by 10% to 20% and 35%, respectively. In terms of the purchase restriction policy, Shanghai has also further relaxed the purchase restriction policy for non-Shanghai residents, and families with many children with two or more children (including households registered in the city and those not registered in the city) can purchase 1 more housing unit on the basis of the implementation of the existing housing purchase restriction policy. Meanwhile, both Shanghai and Shenzhen lowered the lower interest rate limit for personal housing loans, while Guangzhou directly abolished this lower limit.

3) The US core PCE rose 2.8% year on year in April, while the overall economic growth rate slowed markedly in the first quarter. Data released by the US Department of Commerce on Friday showed that after excluding food and energy prices, the core PCE index rose 0.2% month-on-month and 2.75% year-on-year in April, the lowest level since April 2021. As one of the indices that the Federal Reserve is very concerned about, the decline in core PCE also caused interest rates on 10-year US bonds to cool down to around 4.5% last Friday. Meanwhile, after adjustments, the US economic growth rate slowed in the first quarter of this year to a greater extent than previously anticipated. US GDP growth in the first quarter was about 1.3%, lower than the previous estimate of 1.6%, and there was a significant slowdown compared to 3.4% in the fourth quarter of 2023.

4) Liquidity: Southbound capital inflows continued to be strong last week, while overseas capital once again turned to outflows. Specifically, data from the EPFR shows that the outflow of overseas active funds from overseas Chinese stock markets last week was about 40.9 million US dollars, which is narrower than the previous week's outflow of 71.7 million US dollars, and has been outflows for 48 consecutive weeks. However, after the previous three weeks of backflow, passive funds from overseas turned back into outflows again last week. The total amount of outflows was 410 million US dollars. Southbound capital inflows maintained a strong trend last week, with a cumulative inflow of HK$29.7 billion last week, up from the previous week's inflow of HK$10.6 billion.

Focus on events

US PMI data for June 3, China trade data for June 7, China CPI for June 12.

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